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Thinking about leveraging your home equity during retirement?
A lot of homeowners do this with HELOCs and HECMs. In this article, we’ll explain what these letters stand for, how these loans work, and how they’re different from each other.
Using these details, you can decide which type of home equity loan to use.
Home Equity Conversion Mortgages work well for retirees who:
A HECM is one type of reverse mortgage; other types are available too. Learn more about reverse loans here.
Check your eligibility for a reverse mortgage.A Home Equity Line of Credit works well for homeowners who:
The differences between HELOCs and HECMs are key factors when deciding which type of loan you need. But these loans’ similarities can help answer that question, too.
So how are HELOCs and HECMs alike?
By definition, a HELOC is a line of credit. Instead of receiving a large sum of money, the borrower can withdraw money from the credit line as needed. In that way, a HELOC resembles a credit card except with a much lower interest rate.
A HECM can do this, too. With a HECM, borrowers don’t have to get a large sum of cash. They don’t have to receive regular monthly payments, either. Instead, they can set up a credit line to draw from as needed.
By choosing a credit line instead of a lump sum or monthly payments, a HECM borrower can combine the strengths of both loan types: the lower balance, interest, and fees of a HELOC and the zero-monthly payment of a HECM.
Though no payment is due monthly, a HECM must be repaid eventually.
When you open a HECM or a HELOC, the lender places a lien against your home. Through its lien, the lender can claim part ownership of the home if the loan isn’t repaid as agreed.
This isn’t all bad. This is a reason interest rates on these loans are lower than for unsecured loans like credit cards.
But it’s important to know this going in: If you don’t pay off the loan, your heirs will have to, even if they have to sell or forfeit the house to do it.
Since reverse loans like HECMs are retirement products — and since they can pay out a monthly income — some borrowers wonder whether they’d need to pay income taxes on the money.
They don’t. Even though it seems like a source of income, a HECM — like a HELOC — is a loan, and borrowed money isn’t taxed like income. Since it’s not taxable income, the money shouldn’t affect Medicare premiums either.
Borrowed money could affect Medicaid or SSI payments. Those programs base eligibility on your assets which includes money in the bank for more than 30 days, regardless of where the money came from. (You could dodge this problem by using a HECM credit line instead of receiving a lump sum.)
This will seem obvious to most borrowers: Both HECMs and HELOCs charge interest. But it’s not as obvious as you might think.
As a reverse loan requiring no payments, a HECM’s interest can seem hidden. The interest charges — and the annual fees — add money to the loan’s balance as time passes. If years, or decades, pass, the loan’s balance could grow a lot.
Thanks to the HECM’s FHA insurance, heirs won’t be responsible for any portion of the loan that grows beyond the home’s value. Still, borrowers who can afford to pay the HECM’s interest and fees each year shouldn’t need this FHA safety net.
If you can afford its monthly payments, a HELOC has a big advantage: With each payment, you recharge your home equity. You can use the equity again, later. In fact, the same HELOC can be used, repaid, and reused repeatedly during its draw period, which usually lasts 10 years.
You can pay off HECMs, too, but you don’t have to. It’d be up to you, the borrower, to schedule and make payments. If you don’t, and if enough time passes, all of your home’s value could belong to the lender. The lender would sell your home to pay off the debt after you die or move out.
This is fine for borrowers who need cash today more than they need home equity tomorrow. But borrowers who want to control as much equity as possible should choose a HELOC or make voluntary payments on their HECM.
See if you qualify for a reverse mortgage.Our advice is based on experience in the mortgage industry and we are dedicated to helping you achieve your goal of owning a home. We may receive compensation from partner banks when you view mortgage rates listed on our website.