Monthly payments for a limited period, called a “term payment”, can be substantially larger than payments committed for the life of the senior. One application is to incorporate it into a retirement plan as a supplement to a block of financial assets that a senior entering retirement plans to liquidate gradually. The challenge faced by seniors adopting this type of retirement plan is to decide how much of their assets they can draw down each year without running out of money while they are still alive. HECM term annuities delay the process of asset depletion. If the payment on a 10-year payment is adequate to meet the senior’s needs, for example, the senior’s assets can be allowed to grow for another 10 years before asset depletion begins. This substantially reduces the danger of running out.
A term payment can also be used by seniors planning to sell their house in a few years who need additional funds in the meantime. In this application, the HECM is an alternative to a home equity line of credit (HELOC). While HELOC borrowers must pay interest on the amounts they draw, over a short period they can increase their draw by enough to cover the interest, so that the net cash withdrawal is comparable to the draw on a HECM term payment.
The advantage of the HELOC is that the upfront costs are lower – in some cases, zero – and the interest rate in most cases will be lower than the HECM rate plus the HECM mortgage insurance premium. This means that, assuming the borrower withdraws the same amount of cash on both, after any given period the HELOC debt will be lower than the HECM debt.
But the HELOC has significant disadvantages that in many cases will shift the balance of advantage to the HECM.
- The HELOC borrower must qualify based mainly on income and credit, as with any forward mortgage. Many seniors won’t qualify for a HELOC.
- If the senior changes her mind about selling the house and decides she wants to remain, she is in trouble if she took a HELOC because the HELOC must be paid off. The HECM doesn’t.
- The borrower using a HELOC as a source of additional cash is dependent upon being able to draw against the unused portion of the credit line. But the lender can cancel the unused line at any time, and will if a question arises about the borrower’s credit, income or property value. This is not a risk with a HECM.