Most people want and prefer lower interest rates when it comes to loans and mortgages, especially those that have a large loan balance. Considering that the interest is your cost of borrowing money, I agree that a lower rate is generally better generating a lower overall cost to borrow the money. However, there is a unique situation in which having a higher interest rate on a loan is an advantage. Yes, that is correct, having a higher interest rate is more advantageous in the long run.
That is with a Home Equity Conversion Mortgage (HECM) and the growing Line of Credit (LOC). As you probably know by now, a HECM is a type of reverse mortgage that is insured by the Federal Housing Administration (FHA). With this type of mortgage, there are two primary components to the mortgage: the amount you owe (this is your loan balance), and the money that you have not taken out and you still have access to (this is your Line of Credit). With a HECM, both components are increasing at the interest rate (+0.5% in MIP), your loan balance and your available LOC.
Consider current rates at around 7.5%. This means that your available funds in your LOC will be growing at 8% (7.5% + 0.5%) annually and compounding monthly. So, imagine a scenario in which you don’t need the money today and you have time to wait before you want or need the money. Let’s look at this scenario below:
A 62-year-old couple has a home worth $715,000 and no mortgage today. They can get a LOC for around $200K today. Assuming interest rates remain where they are and average 7.5%, the available funds in their line of credit will grow to be around $982,000 over the next 20 years. This means that when the couple is 82 years old, and they have a higher probability of needing more money for home improvement or long-term care needs, they will have access to almost $1M in their LOC. That is right, they will have almost $1M in liquid funds from their HECM line of credit.
Now let’s say this couple did a great job of planning and they do not need the money until they are 90 years old, the available funds in their LOC would continue to grow and ultimately provide them access to over $1.8M. Keep in mind a few important elements to the money in the LOC as well:
- This money is also free of any income taxes (this is not considered income and there are no income taxes on this money).
- The available funds are guaranteed to grow, regardless of what happens to their home value, even if the home value never appreciates again or goes down in value.
- The funds from the LOC can be used for anything, there are no limitations on how you use the money.
- Your home is likely to continue to appreciate as well given that homes in the US have historically appreciated by around 4% annually (although that of course is not guaranteed).
In conclusion, if you do not have a mortgage today, or you have a very small mortgage balance and a lot of equity in your home, you might be a great candidate for a HECM LOC, even if you don’t need the money today. Given the fact that interest rates are the highest we have seen in over 20 years, this is an advantage today since the available funds in the LOC will grow at the interest rate +.5%.
Please note, this option is not available on a fixed rate and is only available on the HECM ARM option.
