Reverse Mortgage Glossary
How the HECM Line of Credit Works (and Grows)
A HECM line of credit (LOC) is one of the most ideal options for receiving proceeds from a HECM reverse mortgage. Many wealthy seniors take advantage of this option because it can essentially turn a large portion of your home’s equity into a tax-free retirement account that will grow larger over time.
The line of credit works very similarly to a home equity line of credit (HELOC) because the available credit is accessible at any time and interest accrues only on what you use. And because this is a reverse mortgage we’re talking about, no monthly payment is required and the money used does not have to be paid back in this lifetime as long as you pay required property charges (property taxes, homeowner’s insurance, HOA dues, etc.) and at least one borrower (or eligible non-borrowing spouse) is living in the home.
Note that the HECM line of credit is available only on the variable-rate HECM. The other options include term payments, tenure payments, lump sum, or some combination of all the options.
The fixed-rate HECM only offers the option to take proceeds as a one-time lump sum payment.
Line of Credit Growth Rate
One of the best features of a HECM line of credit is that it accrues growth over time, which gives you access to more money automatically based on an annual growth rate. Because of this growth, the line of credit can essentially turn a large chunk of the value of your home into a liquid, tax-free retirement account that will increase in value over time. As long as you uphold your end of the bargain (live in the home and pay required property charges), the available line of credit will grow and compound with no limit.
As an example, let’s assume you qualify for a line of credit that starts at $150,000 and has a growth rate of 5%. If you don’t pull out any money, the line of credit will grow to $157,500 after just the first year. If you leave it alone for 5 years, the line of credit will grow to $191,442.23 (assuming the growth rate doesn’t change).
As you can see, this can turn an asset that does largely nothing for you – your equity – into a liquid asset that grows and appreciates and can help fund your retirement lifestyle. The line of credit option can be particularly advantageous if you’re early in retirement and have a home with little to no mortgage balance. This means you can maximize the size of the line of credit and the compounding growth over time.
It’s important to understand that growth accrues only on your available credit. The growth stops once you use up the entire credit line.
If you have a variable-rate HECM with a line of credit, try to keep as much money available in the line of credit as possible so you can maximize the growth. Only pull out money if you really need it for something. It doesn’t make sense to pull out money and leave it just sitting in a checking or savings account earning almost zero interest. You’re missing out on growth that could be accruing on that money in the line of credit.
How the Growth Rate is Calculated
As crazy as it might sound, higher rates might be beneficial if you have a large available line of credit. If the IIR goes up, so does the growth rate, which means your line of credit grows and compounds that much faster.
The 60% Utilization Rule
FHA made an important change a few years ago that limits how much of your available credit line you can access in the first 12 months of the reverse mortgage. If your mandatory obligations are less than 60% of the principal limit, you’ll be allowed to withdraw up to 60% of the principal limit in the first 12 months. The remainder of the line of credit will come available at the one-year anniversary of the loan.
If your mandatory obligations are greater than 60%, you’ll be able to withdraw up to another 10% of the principal limit in the first 12 months. Any remainder will come available at the one-year anniversary of the loan. Note that a higher IMIP rate applies if your mandatory obligations are higher than 60%.
FHA made this change to help slow down people from burning through the reverse mortgage proceeds too quickly and having nothing left. The idea was to encourage longer-term financial sustainability for reverse mortgage borrowers.