Reverse Mortgage Line of Credit: Why It’s Better Than a HELOC For Retired Homeowners

The reverse mortgage line of credit offers safe and convenient access to home equity in retirement. We’ll explain how it works (including the fantastic growth feature) and why it’s safer than a HELOC for retired homeowners.

Reverse Mortgage Basics

A reverse mortgage enables homeowners 62 and older to convert home equity into cash without a mortgage payment and without giving up ownership of their homes.

The most popular reverse mortgage in the United States today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If you know somebody who got a reverse mortgage, it’s likely they got a HECM.

No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the required property charges.

You always remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home whether they choose to keep it or sell it.

The HECM is a non recourse loan, which means the most that will ever have to be repaid is the value of your home. FHA covers the shortage if your home isn’t worth enough to pay off the entire loan balance.

The HECM is versatile and customizable; you can take the proceeds as a lump sum, line of credit, term or tenure income, or some combination of all of these options.

How the HECM Line of Credit Works

In my opinion, the reverse mortgage line of credit is the best way to take proceeds from a HECM reverse mortgage.

The line of credit is similar to a home equity line of credit (HELOC), but without the risks and potential headaches of a HELOC – which we’ll cover in a moment.

You can access the available credit at your convenience on a revolving basis and interest accrues only on the money you borrow.

Again, no monthly payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the required property charges.

Unlike a HELOC, you can rely on the reverse mortgage line of credit to be there when you need it. As long as you uphold your end of the bargain, your credit line cannot be locked, chopped, frozen, or taken away.

Your line of credit is even backed by FHA if your lender goes out of business.

Reverse Mortgage Line of Credit Interest Rate

A reverse mortgage is a home loan, so it has an interest rate like any other home loan.

The line of credit reverse mortgage comes with an adjustable rate called the initial interest rate. Yes, the rate can move around over time, but it’s usually based on a relatively stable treasury index.

The rate is also limited by caps, which means it can’t go crazy even if interest rates increase drastically.

Since mortgage payments aren’t required (as long as you remain in good standing), any unpaid interest simply accrues onto the loan balance.

Annual MIP also accrues onto the balance with the interest. Annual MIP helps make the HECM non recourse, which means FHA covers any shortage if your home isn’t worth enough to cover the entire loan balance.

The total interest on the reverse mortgage equals the initial interest rate plus the annual MIP rate.

Reverse Mortgage Line of Credit Growth Rate

The best feature of the reverse mortgage line of credit is that it grows larger based on an annual growth rate. It’s designed to give you access to more equity over time automatically.

The growth feature essentially turns a portion of the value of your home into a liquid, tax-free “retirement account” that increases in value over time with no limit.

The reverse mortgage line of credit growth rate always equals the total interest rate (initial interest rate plus the annual MIP rate). For example, if the initial interest rate is 4.50% and the MIP rate is 0.50%, the growth rate would be calculated as follows:

4.50% (initial interest rate) + 0.50% (annual MIP) = 5.00% growth rate 

The growth rate is designed to change with prevailing interest rates. If the initial interest rate increases, the line of credit growth rate will increase as well. If the initial interest rate decreases, the line of credit growth rate will also decrease.

It might sound crazy, but higher interest rates could be hugely beneficial if you have a huge line of credit. Higher rates will drive up your growth rate, which means your line of credit will grow faster.

A HECM Line of Credit Example

To see how the growth works, let’s check out a HECM line of credit example. Let’s assume you qualify for a HECM line of credit that starts at $150,000 and has an annual growth rate of 5%. The table below shows how your available credit will grow over the next ten years.

As you can see, the available credit grows to $157,674 after just the first year. After five years, the available credit will grow and compound to a whopping $192,504 (assuming the growth rate doesn’t change). 

As you can see, the growth turns something that largely does nothing for you – your home equity – into a liquid and performing asset that can help fund your retirement lifestyle.

A line of credit reverse mortgage is particularly advantageous if you’re early in retirement and have a home with little to no mortgage balance. You have a lot of years to let the line of credit grow and compound, which means you’ll have a lot money to work with in the future when you need to cover home maintenance and repairs, medical expenses, or long-term care.

Reverse Mortgage Line of Credit Pros and Cons

Now that we’ve covered the basics, let’s sum up the reverse mortgage line of credit pros and cons. Let’s start with the “pros” first:

• The convenience of a HELOC – A HECM line of credit has the convenience of a HELOC; you can borrow on a revolving basis whenever you like.
• No monthly payments – No mortgage payments are required as long as at least one borrower or non-borrowing spouse lives in the home and pays the required property charges.
• Non-recourse – Unlike a HELOC, a reverse mortgage line of credit is non-recourse. FHA covers the shortage if your home isn’t worth enough to cover the entire loan balance.
• Line of credit growth – Your available credit will grow and compound based on an annual growth rate. The reverse mortgage line of credit is designed to give you access to more equity over time automatically if you need it.
• Reliable – As long as you uphold your end of the bargain, you can rely on the HECM line of credit to be there when you need it.

Now that we’ve covered the positives, let’s cover the negatives:

• Closing costs – Reverse mortgage closing costs are typically much higher than HELOC closing costs. To get a reverse mortgage line of credit, you’ll likely incur IMIP, third party closing costs, and an origination fee. The costs aren’t cheap, but here’s the good news: they’re typically not paid out of pocket. Most lenders will roll the costs into the new loan, which means you won’t need to pay them out pocket.

Again, the closing costs aren’t cheap, but you get a lot for them. In our opinion, the reverse mortgage pros and cons balance out in favor of the “pros” for most homeowners.

Reverse Mortgage vs HELOC

So, reverse mortgage or HELOC? Which one makes more sense for retired homeowners? What is the difference between a reverse mortgage and HELOC?

The HELOC is a great loan product, but it’s risky for retired homeowners, in my opinion. In the reverse mortgage vs HELOC debate, I think the HECM line of credit comes out on top – by a long shot. Here are some reasons why.

• Interest-only payments – HELOCs typically have low minimum payments that cover just the interest. You have to make extra payments to actually pay down the debt.
  
  In my experience, most seniors with HELOCs make just the minimum payments. The balance almost never goes down. In fact, the balance usually goes up as the homeowner continues to borrow to supplement income or pay for unexpected expenses.
• Adjustable interest rates – Most HELOCs have adjustable interest rates based on the prime rate. If the prime rate increases, the payment increases as well.
  
  Many seniors with HELOCs discovered this the hard way as the COVID pandemic wound down. Inflation took off, so the Federal Reserve began increasing interest rates. The prime rate skyrocketed from 3.25% in early 2022 to 8.25% by the end of 2023. Ouch!
• Full recourse – If home values fall and you owe more than your home is worth, you’ll be on the hook for the shortage if you try to sell your home. You will either have to come up with a lot of cash or negotiate a short sale.
  
  If you negotiate a short sale, you may have to pay income taxes on the forgiven loan amount.
• Unreliable – You can’t rely on your HELOC to always be there when you need it. If your bank gets worried about the economy or home values, they may chop, revoke, or freeze your available credit line with little notice.
  
  It doesn’t matter if you have excellent credit, tons of home equity, or you’ve been with your bank for 40 years. If the bank sees risk, they’ll take steps to reduce it by eliminating outstanding credit lines.
  
  This happened to many homeowners in 2021 when Wells Fargo closed all of their personal lines of credit. Again, you can’t rely on your HELOC to always be there when you need it.
• The recast – Of all the HELOC loan risks, this one is the worst, in my opinion. Let me explain how the recast works and why it’s a big risk for homeowners on a fixed income.
  
  Most HELOCs allow you to withdraw funds for up to the first ten years of the loan. This is called the draw period.
  
  At the end of the draw period, the bank recasts (or recalculates) the loan payment into a full principal and interest payment that pays back the entire outstanding balance over the remaining loan term.
  
  HELOCs usually have a 20- or 25-year total loan term, which means the remaining loan term at the end of the 10-year draw period is usually around 10 to 15 years. When the bank recasts the payment, they’re essentially giving you a fully-amortized 10- or 15-year loan, which means you end up with a big monthly payment.
  
  To see how devastating this can be – especially in a rising rate environment – let’s check out an example.
  
  Let’s assume we have a retired homeowner named Phyllis who opened a 25-year $50,000 HELOC back in 2014. Phyllis didn’t use the HELOC until late 2021, when she borrowed the full $50,000 to do home renovations.
  
  In late 2021, HELOC rates were super cheap. Her interest rate was around 4%, which meant her interest-only payment was just $167/month. For Phyllis, using her HELOC was a fantastic deal. She was able to redo her kitchen and two bathrooms for a mere $167/month.
  
  Unfortunately for Phyllis, inflation took off after the pandemic, so the Federal Reserve began increasing interest rates. By late 2023, her interest rate hit 9.25%, which meant her interest-only payment more than doubled to $385/month.
  
  Even worse, Phyllis reached the end of the draw period in 2024. Her bank recalculated her payment so she would repay the entire $50,000 balance over the remaining 15 years of the loan term. The recast caused her payment to jump to a whopping $514/month. Ouch!
  
  Phyllis’ payment tripled in just three years because of rate increases and the recast. If Phyllis can’t afford her new payment and falls behind, she could face foreclosure.

The point here is not to bash HELOCs as a bad loan product. In fact, they’re a great loan product, but they have to be used for the right purpose. I think a HELOC is best used for short-term cash needs where you borrow and repay in a relatively short timeframe.

A HELOC is risky if you’re on a fixed income and carry a large balance for many years. As we’ve covered here, a HELOC recast can come back to bite you down the road.

So, in the reverse mortgage or HELOC debate, I think the HECM line of credit absolutely comes out on top for retired homeowners. It offers the convenience of a HELOC, but without the risks.

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