LTC Bullet: On Using Home Equity for LTC
Tuesday,
March 21, 2006
Las
Vegas, NV--
LTC
Comment: Should consumers take the Wall
Street Journal's advice and use home equity lines of credit (HELOCs) or
utilize home equity conversion mortgages (HECMs) instead?
More after the ***news.*** [omitted]
LTC
BULLET: ON USING HOME EQUITY FOR
LTC
The
following article was first published in The Mortgage Press, April 2006.
It is reprinted with permission. For
the record, LTC Bullets does not share the author’s positive opinion of
Mr. Clements's WSJ column, where he often gives highly questionable
advice about long-term care planning.
-----------
"What
the Wall Street Journal Failed to Tell Readers about HELOCs vs. HECMs"
by Atare E. Agbamu, CRMS.
One
of my favorite columns in the business world's preeminent daily business
newspaper is "Getting Going" by Jonathan Clements. Mr. Clements dispenses generic personal finance advice.
He is one of the best in the business.
In
a piece titled "Five Strategies for Helping Your Parents -- And Getting
More From Their Estate" (WSJ, January 18, 2006, page D1), Mr.
Clements gave some advice on home equity lines of credit (HELOCs) versus reverse
mortgages (HECMs) that illustrates the dangers of giving and taking generic
financial advice from otherwise very good financial generalists.
In strategy #4, 'Taking Credit,' here is Mr. Clements's sage advice:
"Later
in retirement, if the parents start running short of money, they might be
tempted to tap into their home's value through a reverse mortgage.
But these loans, which usually don't have to be repaid until after the
parents die, can involve closing costs of as much as $20,000.
"To
avoid that eye-popping expense and preserve money for their children, the
parents could opt instead for a home equity line of credit, which will also
allow them to borrow against their home's value, but should cost little or
nothing to set up. There is,
however, risk involved. Unlike a
reverse mortgage, the parents will have to make regular repayments on the credit
line during their lifetime.
"They
could keep up those repayments for a bunch of years, simply by drawing down the
credit line even further. But
eventually, the credit line might be tapped out -- and the parents could find
themselves in a nasty cash crunch.
"Sounds
scary? Maybe, if it gets to that
point, the children could commit to making the minimum payments on the credit
line."
To
his credit, Mr. Clements mentioned the risk of a cash crunch.
The cash squeeze comes from the monthly repayment obligation of a HELOC.
In addition to their monthly cash draw for living expenses, the repayment
obligation will compel Mr. Clements's HELOC borrowers to use principal to pay
principal. With variable interest
rates on HELOCs, this "strategy" can quickly liquidate the borrower's
home equity. Home equity conversion
mortgages or HECMs (a.k.a. Reverse Mortgages) have no repayment requirements for
as long as the borrowers live in their home.
So,
for "little or nothing to set up," those who follow the Wall Street
Journal's "strategy" could end up not only rapidly running through
their home equity, but also confiscating extra cash from their children to pay
the lender. Let's take a moment to
review some relevant questions:
*
What happens if the kids are unable to make the "minimum" payments for
their parents?
*
What is the cost of the "minimum" payments to the kids?
*
What if the parents live for twenty-five more years?
*
Why should the kids commit to transferring "minimum" payments to a
lender when they could be using those "minimum" payments to shore up
their own retirement portfolios?
*
Why should the kids follow a "strategy" that guarantees loss of their
inheritance while putting their parents on the streets?
If
the Wall Street Journal were some provincial business paper and Jonathan
Clements were an upstart financial columnist, I would not bother to write this
response. The Wall Street
Journal is the king of business dailies, and Mr. Clements is a respected and
influential columnist. I personally
enjoy reading his fine column. But
I believe his strategy #4 is ill-advised and could hurt those who follow it.
Here are my reasons:
Reason
# 1 - Monthly Repayments:
The
HECM borrower has no monthly repayments to make; the HELOC borrower must make
monthly repayments. If they fail to
make payments, they lose their home, their shelter, and their place.
Reason
# 2 - Non-Recourse Home Loans:
HECMs
and all reverse mortgages are non-recourse loans.
The parents' children and heirs are not liable for repayment.
The lender is legally forbidden from looking beyond the property to
recoup any loss it may suffer in a reverse mortgage transaction.
Can you put a dollar sign on the value of this protection for an older
adult? The HELOC loan does not offer this vital protection.
If the home securing the HELOC falls in value below the cash the lender
advances the parents, the parents could lose more than their home.
Reason
# 3 - Asset Protection:
HECMs
and reverse mortgages guarantee borrowers against losing their homes even if
they exhaust their available equity, provided they pay their property taxes and
homeowners insurance. HELOCs do not
offer similar structural legal guarantee.
Reason
# 4 - Consumer Education:
HECMs
and reverse mortgages mandate consumer education from trained and certified
reverse mortgage counselors before a borrower can get a reverse mortgage.
HELOC borrowers are on their own on a decision that could cost them their
home.
Reason
# 5 - Little Cost to Zero Cost Reverse Mortgages:
Not
all reverse mortgages come with an "eye-popping" entry fee.
There are proprietary reverse mortgages with little to zero set up fee.
HELOCs have "little" set up fee.
Reason
# 6 - Full Disclosure:
HECM
and reverse mortgage lenders are required to make "Total Annual Loan
Cost" or TALC disclosure over the projected life of the loan.
In its rigor, the TALC disclosure has no parallel in the world of HELOCs
and traditional forward mortgages. All
costs, including servicing costs for the life of a reverse mortgage must be
disclosed to the borrower. HELOCs
hide servicing costs in the interest rates.
The ubiquitous "APR" does not tell the entire story on HELOCs's
hidden costs.
Reason
# 7 - Lower Long-Term Costs:
It
is a fact that the longer you keep a HECM loan, the lower the total annual loan
cost (TALC). With HELOCs, the
opposite is true. For folks already
"running short of money," qualifying for HELOCs could be tough because
they must show lender that they have sufficient income to pay back.
While lack of income may not prevent them from getting a HELOC loan today
because of availability of "Stated Income" or "No Income/No
Documentation" programs, it would exact a heavy price:
higher interest rates relative to tamed HECM rates.
So, for "little or nothing to set up," Mr. Clements's HELOC
borrowers could be saddled with higher interest rates (costs), higher monthly
repayments (headaches), faster depletion of their home equity (heartburns),
quicker march into default and foreclosure (mortal terror in a season of
respite).
Yes,
HECMs and some reverse mortgages can be "expensive" to set up.
And it is tempting to focus on the costs and ignore the incomparable
benefits. The real question should
be: for the right borrower, is it
worth it? On a cost-value basis, my
money is on HECMs and reverse mortgages.
Think
reverse. Move forward!
About
the author: Atare E. Agbamu, CRMS,
is President of ThinkReverse LLC in Oakdale, Minnesota. ThinkReverse LLC helps
mortgage originators address demographic change through reverse mortgage
training and consulting. Besides
marketing, originating, and researching reverse mortgages, Mr. Agbamu has
authored over 50 articles on reverse mortgages through his nationally
distributed column in The Mortgage Press. His
book, Think Reverse! (a guide to marketing and originating reverse
mortgages for mortgage professionals and older financial advisors) will be
published by The Mortgage Press, Ltd. in June.
He can be reached at (612) 203-9434 or atare@thinkreverse.com. |