Progress means everything in the financial world. Whether you’re building a college fund for your child, analyzing your retirement savings, or considering a Home Equity Line of Credit (HELOC), making headway matters. Today, reverse mortgages are available in many different shapes and forms that suit a variety of client needs. For borrowers seeking another means of long term financial stability, the reverse mortgage line of credit may provide a satisfactory alternative to a standard loan. But, many clients are often confused by the line of credit itself. How does this product grow, and how does it help to protect its clients from financial insecurity?
Growth Rates Explained
One great advantage that the line of credit has over other programs is its capacity for growth. Unlike a traditional reverse mortgage, in which the principal available limit (how much money you can access) is withdrawn in a lump sum immediately after the loan’s closing, the line of credit offers a more flexible long term safety net. Like other reverse mortgage products, the reverse mortgage line of credit converts your home’s equity into usable funds, but unlike the lump sum, these proceeds may appreciate over time.
As long as the funds in a line of credit go untouched, they may grow according to an adjustable rate. You can withdraw whatever you need, and the remaining sum in your line will continue to grow. Let’s look at an example of a $200,000 available principal limit. If you use $100,000 from that sum to pay off your mortgage and various other expenses, the remaining $100,000 will grow at the rate charged on the loan combined with an additional 1.25% from the mortgage insurance premium. That is why we recommend every homeowner who is 62 to consider getting a reverse mortgage line of credit. We also recommend borrowers to refrain from withdrawing funds for as long as possible (if they can) so that you will get the greatest amount of growth. Keep in mind, however, that this growth rate is not “interest,” although the concepts may appear similar.
An untapped line of credit will grow at this rate and the money will compound gradually, thus giving you an increasing amount of growth as your line of credit grows larger and larger. The growth rate itself is determined based on three separate factors. The first is the current index value, the second is the margin, and the third is the annual mortgage insurance premium that is received by the Federal Housing Administration. Even though the line of credit uses an adjustable rate that may change over time, it’s helpful to know that the margin itself (a component of the total rate) is a fixed rate that will remain constant throughout the life of the loan, meaning that the loan will always continue to grow, if only marginally.
How Growth Affects You
So, how does the HELOC’s growth rate affect your personal finances? Well, for one, the growth rate isn’t tied to your home’s value, it’s tied to the LIBOR index, which is an international standard for interest rates. If your home decreases in value due to a housing market slump, your line’s growth rate may not fall because it isn’t directly connected to the housing market.
Additionally, the compounding growth of the line of credit encourages particular spending habits, or rather, an absence of spending habits. The optimal strategy when getting a reverse mortgage line of credit is to spend as little money as possible. The larger the sum, the larger it will grow, and in some cases, given enough time, the funds may even exceed the home’s value. That’s why, upon getting a line, your best course of action may be to leave the money alone and wait for it to grow if you can. If you give your line of credit the time to grow and flourish into a much larger sum than you’d initially started with, you’ll have a much greater chance of dealing with sudden expenses such as medical bills or surprise repairs. The line of credit is a complex tool, but it’s easy to manage once you understand how it works.