By George A. Downey
The Federal Reserve commitment to continue increasing interest rates to fight inflation will increase monthly payments for borrowers with adjustable-rate debt at a time of intensifying financial insecurity.
The Feds took the punch bowl away this year – the stimulus payments are over and the historically low interest rate policy they provided has given way to unprecedented rate increases. Most concerning now is the impact of interest rate hikes on consumers who hold a credit card balance, a Home Equity Line of Credit (HELOC), or other adjustable-rate debt – especially for older Americans with limited incomes and savings.
Credit Cards and Adjustable-Rate Debt. Data produced by CreditCards.com reveals the average general purpose credit card APR is 22.66% and retail credit cards even higher at 26%. Given current Fed rate policies, increased rates changes will increase payment obligations, further burdening consumer budgets.
Home Equity Lines of Credit. HELOCs have proven to be an easy and affordable way to tap home equity. Featuring low or no upfront costs and interest only payments for a set period, most commonly the first ten years, HELOCs have been a mainstream solution to borrowing on home equity.
However, many borrowers have forgotten that when the initial borrowing term expires: (1) the credit line is frozen, (2) the interest rate continues to adjust, and (3) the monthly payment is increased to pay the balance off over the remaining term.
Borrowers have three options: (1) continue making higher monthly payments, (2) paying the balance off with other funds, or (3) refinancing to a new HELOC or another mortgage program if they can qualify.
Unfortunately, many older homeowners are no longer eligible for refinancing due to more stringent financial and credit qualifications lenders are required to document. Fortunately, a reverse mortgage may provide a solution to resolve this problem and facilitate the fulfillment of other financial and retirement planning objectives.
Good Debt / Bad Debt – What’s the difference?
The old maxim that there is no good debt in retirement is a bit worn out. If you have debt it must be dealt with sooner or later. A better perspective may be – debt that requires payments from current income and/or savings is an ongoing threat to savings and financial security. On the other hand, debt that is secured by other assets and defers payment obligations may provide a better solution.
Reverse Mortgage – Eliminates Monthly Payment Obligations
Older homeowners (62 and older) may be eligible to refinance to a reverse mortgage that defers all payment obligations permanently. No repayment is required until the homeowner sells or no longer resides in the property. Depending on individual circumstances, all existing liens are paid off eliminating their payment obligations. Further, additional funds or a line of credit will be made available for any surplus. The unique terms of reverse mortgages were developed to meet needs of aging homeowners, who do not want to sell, but wish to remain in their home to age in place.
The HUD/FHA insured Home Equity Conversion Mortgage (HECM) reverse mortgage is the dominant program nationally, accounting for over 95% of all reverse mortgage programs. HECMs are most suitable for home values up to $1,089,300 in 2023. Higher valued properties may be better served by new proprietary or jumbo programs.
Financial Advisors Utilizing Housing Wealth in Financial Planning
Residential home values have achieved record highs in recent years. Recognizing an opportunity, savvy planning professionals are exploring best practices to take advantage of current values and lock in higher loan amounts that may be needed and/or be better positioned to fulfill client objectives.
To a large extent, home equity (housing wealth) has not been a mainstream tool in the financial planning process. That is changing. Converting a portion of home equity to a line of credit and/or additional cash through a reverse mortgage is one strategy advisors are now exploring to cope with the financial setbacks and enable clients to maximize use of all their resources.
Reverse Mortgage Overview
- No monthly payment obligations – prepayments are permitted without penalty but not required. Monthly charges are deferred and accrue until the home is eventually sold.
- Credit line growth – the undrawn balance of the credit line grows (compounding monthly) at the same rate charged on funds borrowed.
- No maturity date – repayment not required until no borrower resides in the property.
- Non-Recourse loan – neither borrowers nor heirs incur personal liability. Repayment of loan balance can never exceed the property value at the time of repayment. If loan balance exceeds property value at time of repayment the lender and borrower(s) are protected by FHA insurance.
- Access to funds and loan terms are guaranteed – cannot be frozen or cancelled as long as the loan remains in good standing.
- Borrower obligations (to keep loan in good standing) are limited to:
- Keeping real estate taxes, homeowner’s insurance, and property charges current
- Providing basic home maintenance
- Continue living in the property as primary residence