A HECM line of credit (LOC) is arguably the best way to receive 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. However, no monthly payments are required for the reverse mortgage as long as you live in your home and pay the required property charges.
Note that the HECM line of credit is available only through the variable-rate HECM which, incidentally, also offers term income, tenure income, lump sum, or some combination of all these options.
A fixed-rate HECM is available as well, but it only offers the option to take proceeds as a one-time lump sum payment at closing. The fixed-rate HECM does not offer a line of credit.
Line of credit growth rate
One of the best features of a HECM line of credit is growth, which gives you access to more money automatically based on a guaranteed 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 growth (which compounds) 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
The growth rate is calculated by adding the annual MIP rate to the initial interest rate (the actual note rate at which interest accrues on the loan). If the initial interest rate increases, the growth rate will as well.
As crazy as it might sound, higher rates might be beneficial if you have a large available line of credit. If the initial interest rate goes up, so does the growth rate, which means your line of credit grows and compounds faster.
The 60% utilization rule
FHA made an important change a few years ago that limits the amount of credit line available in the first 12 months of the loan. If your mandatory obligations are less than 60% of the principal limit, you can 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 can withdraw up to another 10% of the principal limit (not to exceed the principal limit, however) in the first 12 months. Any remaining principal limit will come available at the one-year anniversary of the loan.
FHA made this change to encourage long-term financial sustainability. FHA doesn’t want borrowers burning through the proceeds too quickly and having nothing left.