Senior citizen homeowners who are house rich but cash poor; are looking for ways to tap their home equity to supplement retirement income. Reverse mortgages - particularly the HUD Home Equity Conversion Mortgage (HECM) - are tools designed specifically for this purpose. HECM’s can be complex, but in their most basic form, they allow senior homeowners to borrow against their home’s equity and receive a monthly payment for as long as they own the home. No matter how much is borrowed, the amount that must be paid back can never exceed the value of the home and is not due until the homeowner either sells the home or dies.

But though HECM popularity is on the rise (more than 43,000 loans were originated in the most recent year), they do not always offer the best option for senior homeowners. Other home equity extraction tools, such as conventional home equity lines of credit (HELOCs), can be more cost-effective in some situations. This article reviews several considerations to weigh in deciding between a HELOC or a HECM loan.

• Will You Remain in the Home for at Least 5 Years? Because of high closing costs, a reverse mortgage is a very expensive way to borrow if the homeowner moves out or dies during the early years of the loan. If there is good chance you will not be in your home for at least 5 years, you likely will be better off borrowing via a home equity line of credit (HELOC). With a HELOC there are typically small (even zero) closing costs to consider. The main downside is that if draw on on the line of credit, you must make a monthly payment to the lender. HELOCs requiring interest-only payments for the first 7-10 years are readily available and can help minimize the monthly payment burden.
• Do You Have Steady Income?Another downside of a HELOC is that you will need to show the lender that you have recurring income or other financial wherewithal to make monthly payments. While this is a challenge for many elderly homeowners, many also enjoy regular pension income together with social security and can meet lending guidelines. These homeowners may be considering borrowing not for basic living expenses, but, rather, to enrich their quality of life.

  Even if don’t have a steady, recurring income but your home equity position is strong, you will still find lenders willing to loan to you. It will then be your responsibility to alter household budgets to accomodate required monthly loan repayments. For short periods, it may be possible to cover monthly payments by drawing against the HELOC itself (i.e. borrowing more to make loan payments), but for longer periods this tactic will not work. With any form of home equity debt,always remember that your home is pledged as collateral and can be foreclosed upon if required payments are not made.

• Is it Important to Keep Options Open? Even if you don’t think you’ll move within 5 years, you may want to keep as many options open as possible. The decision to take out a reverse mortgage is also a decision to limit your options in couple of important ways. First, as noted, you need to stay in the home long enough to spread the high closing costs out over several years for the loan to be sensible.

  Second, depending on interest rates, home values and other factors, the rising debt of a HECM will eat into your home equity and limit future financial flexibility. The same factors are at work with a HELOC loan, but you have more flexibility to refinance - even into a reverse mortgage product - at a later date.

• Are You Too Young or Too Old? Age matters a lot in the reverse mortgage arena. Although HECMs are available to senior homeowners age 62 and older, the best age for reverse mortgage borrowers seems to be about 75. This is an age at which you can get a decent loan amount and still have enough years left to smooth out the impact of high origination fees. The amount that can be borrowed with a HECM is largely determined by actuarial life expectancy tables - the younger the borrower, the longer his or her life expectancy and the less the amount of the loan. Fees, however, generally are not age dependent. As examples, using the reverse mortgage calculator available at the National Reverse Mortgage Lenders Association (NRMLA) website, sample loan estimates were computed for a $200,000 home for a single homeowner at three ages:

  62-year old - Estimated fees are $14,782 or 14.7% of the computed loan principal amount (before fees) of $99,954. This homeowner could receive a monthly tenure payment of $494 as long as he stayed in the home.

  75-year old - Estimated fees are $14,130 or 11.7% of the computed loan principal amount (before fees) of $120,842. This homeowner could receive a monthly tenure payment of $708 as long as he stayed in the home.

  85-year old - Estimated fees are $13,100 or 9.5% of the computed loan principal amount (before fees) of $137,933. This homeowner could receive a monthly tenure payment of $1,078 as long as he stayed in the home.

  Thus, the younger person suffers from both a relatively paltry available loan amount and because fees - as a percent of the loan amount - are inordinately high. The 85-year old seems to win on both these counts, but only because his life expectancy is relatively short. Moreover, there is a greater chance that an 85-year old will need to permanently leave the home on an unplanned basis for assisted living. Of course, the homeowner’s general health condition needs to be considered as well as age.

• Is there a Big Age Difference between Homeowners? HECM reverse mortgage calculations are always based on the age of the youngest homeowner. Thus, for a 75-year old homeowner having a 62-year old spouse, the age used to calculate the HECM loan amount is 62. Moreover, if the spouse is under age 62, the reverse mortgage option won’t even be available unless the home is re-titled in the older spouse’s name only.
• Is Tax Deductible Interest an Important Consideration? Interest on a home equity conversion mortgage (HECM) is not deductible until paid - i.e. when the house is sold or the homeowner dies. At that point, the deduction may be of little or no value. Interest on a HELOC, however, is paid each month and - if you itemize deductions - is deductible in the year paid. In the early years of a HELOC your payment likely will be all interest. Some seniors with taxable earnings or taxable retirement income distributions (IRA, 401k, etc.) may find it more advantageous to borrow through a HELOC rather than a HECM for this reason.
• Is the Loan to Replace Interest or Other Cyclical Income? Retirees often depend on income from CD’s or other investments to supplement their social security and pension income. When interest rates decline, they may look to a reverse mortgage to replace the lost income. But while interest rates are likely to rebound over a 3-5 year cycle, the decision to take an out a reverse mortgage should be made with a longer-term perspective. A HELOC may be a more cost-effective tool to bridge an interest income gap for periods of five years or less.
• Is the Loan Primarily Needed for Unforseen Emergencies? If the main goal is to have funds readily available in event of an unexpected need, a low-cost HELOC is likely the better alternative. A HELOC can remain available but unused until needed without significant cost to the homeowner. A HECM, on the other hand, entails high origination fees and closing costs regardless of whether the loan is used or remains untapped.

Many financial planners characterize HECMs as a “loan of last resort” primarily for lower income seniors - a loan to be used only when there are no other options available to fund retirement living expense or healthcare costs. This characterization is oversimplified. Many retirees have found that reverse mortgages fit their needs nicely and provide a measure of security that other tools cannot match. They utilize reverse mortgages for to fulfill lifelong dreams, travel, continue college, or any number of other life-enriching uses. But there are alternatives available that seniors can use to tap their home equity. Carefully weighing all options will help you select the option that best meets your needs.