Using Home Equity to Pay for Elder Care
A Home Equity Line of Credit or HELOC is a loan that is much like a credit card, except with lower interest rates. Borrowers are told the maximum amount they can borrow and then given the flexibility to withdrawal money up to that limit on an as needed basis.
The loan is secured by the home. It can be, and very often is, in second position behind a primary mortgage. With a HELOC, there is a “draw” period, where one is able to withdrawal money, followed by a “repayment” period. The loan, or line of credit, is given for a set period of time from 5 - 25 years, 5 - 10 years being very common for the “draw” period, and 10 – 20 years for the “repayment” period.
During the “draw” period, one may have a minimum monthly payment, which will depend on the amount that has been borrowed. However, this payment may be interest only. At the end of the “draw” period, a borrower pays back the loan in a lump sum, including interest (usually by selling the house), or in monthly payments for the duration of the HELOC. (Interest is only paid on the amount that was actually borrowed during the withdrawal period.) Make note, not all HELOCs offer a “repayment” period, and if this is the case, the full borrowed amount, plus interest, will be due at the end of the “draw” period.
Many seniors are in a situation where they do not have a lot of income or savings to pay for long-term care, but do have financial resources tied up in their home ownership. HELOCs offer a way for seniors to quickly get cash from the value of their home to pay for long-term care or to make home modifications to enable them to continue living independently in their home.
HELOC vs. Reverse Mortgage
HELOCs are often considered as an alternative to reverse mortgages as an option to pay for care. Reverse mortgages are loans for seniors over 62 years of age that allow eligible applicants to receive cash using equity they have in their homes. This type of loan has considerable consumer protections built-in for the elderly, but there are situations where a HELOC is the better option.
- For short term loans of less than five years, HELOCs are more simple with lower associated costs and faster turnaround times. Reverse mortgages have higher closing costs, while costs with a HELOC are low upfront and accumulate over the life of the loan.
- As assurance against unforeseen emergencies. While reverse mortgages can be taken as a line of credit, HELOCs are significantly less expensive to do so.
- If the future is uncertain and the senior has possible large life changes within a few years, HELOCs can offer greater flexibility than a reverse mortgage.
- With mixed age couples; to prevent a reverse mortgage from coming due when one spouse passes away, couples will include both partners as borrowers. This means that both borrowers must be older than 62. Married couples that have large age differences might be in a situation where one spouse is old enough and the other is not. A HELOC may provide a short-term solution until the younger of the spouses reaches the age of 62.
- The amount of money a senior can borrow in a reverse mortgage is calculated on many factors, including the age of the youngest borrower. For borrowers near the minimum age of 62 or for couples with large age differences, the amount that can be borrowed may be too low due to the younger age of one spouse. Therefore HELOCs may provide additional borrowing power to a couple.
- For some tax reasons with a HELOC, monthly interest payments are tax deductible in the year they are paid. With a reverse mortgage, interest is not paid until the house is sold or the owner passes away. For some seniors, usually those with higher incomes, it may be better financially to have the loan’s interest payments deducted annually.
HELOCs do not have the same consumer protections as reverse mortgages. Failure to repay the loan can result in foreclosure. Banks can freeze HELOC loans with little or no warning.
Every senior’s situation is different and in some cases a HELOC is not the best option. Here we explore five common health scenarios and why seniors might want or not want to use a HELOC instead of a reverse mortgage.
1) Single Seniors in Good Health - For these individuals, a HELOC is beneficial only if they need resources immediately and for just a few years. However, since the senior is in fair health, it is unlikely there is an immediate need. These individuals are probably better served with a reverse mortgage.
2) Single Seniors in Need of Care - There is no requirement that seniors remain living in the home as there is with reverse mortgages. Therefore, if a senior needs care that requires them to live outside their home, a HELOC may be a good option. This is especially true since HELOCs are more economical for short-term borrowing. Often moving into senior housing comes as a sudden decision and requires a large upfront, move-in cost. HELOCs can cover these costs while the home is sold.
3) Married Seniors in Good Health - Unless there are large age differences in the couple, married seniors in fair health are probably served better with a reverse mortgage. Being in fair health means they probably don’t require the resources immediately. Additionally, mixed age couples often cannot receive a high enough loan amount to make a reverse mortgage feasible or they don’t qualify since amounts are based on the age of the youngest borrower.
4) Married Seniors with One Spouse in Need of Care - In this situation both options are available to the couple. There is no clear advantage to one type of loan based on the health status alone. Decisions should be made based on the immediacy and the extent of the family’s need.
5) Married Seniors with Both Spouses in Need of Care - With both spouses in immediate or near-term need of care that requires them to live outside the home, the reverse mortgage option is very unlikely. A HELOC is the better short-term option while the family sells the home and then pays for the care with those proceeds.
For some seniors, neither HELOCs nor reverse mortgages are good options. These persons and their families may be helped by a loan designed specifically for senior care. Read more about this option.
- Financial Requirements - Lenders will consider a senior’s income level and debt to income ratio to determine if they are able to make the monthly payments. This can be an obstacle for seniors on fixed or with limited income. However, lenders also realize that elderly individuals can borrow from the loan balance to make the payment and the loans can be structured as interest-only so the monthly payments are very low. An individual’s credit score is also taken into account.
- Home Requirements - Lenders consider the applicant's equity in their home and the existence and amount of other mortgages. In general, most lenders will want applicants to have a loan to value ratio of 80%, at a minimum. This means that homeowners have paid off and own 20% of their home. Note that having another mortgage does not automatically disqualify one for a home equity line of credit.
- Personal Factors Not Affecting Eligibility - Neither age, marital or veteran discharge status nor geographic location directly affect eligibility.
Loan Benefits and Limits
A HELOC is a line of credit, meaning the borrower can take as much of a loan as they want up to a certain predetermined amount. They can borrow as a lump sum, in monthly installments, or on whatever schedule they’d prefer. There are no restrictions on how the proceeds from a HELOC can be used.
In addition to the credit history and income level of the borrower, the limits on a home equity line of credit depend on the amount due on the primary mortgage, if one exists. (Generally the more equity one has in their home, the greater the line of credit one is given). For example, for a home valued at $250,000 with $150,000 due on the primary mortgage, a borrower can borrow against the remaining $100,000. How much they can borrow against that $100,000 depends on various factors; it is safe to assume somewhere between 65% and 80%.
Costs and Fees
Home Equity Lines of Credit are often advertised as having no closing costs. This may or may not be accurate. Sometimes closing costs are hidden in an “annual fee” and it is not always clear what is defined as “closing costs”. Certainly other fees and costs exist, some of which can be waived by request.
- Appraisal fees which can range from $300 - $800.
- Annual fees, charged by some but not all lenders, can be as much as $100 / yr.
- An “early closure release fee” may be charged and can be considerable if one closes the account within the first three years. It is also known as “early closing cost reimbursement” or a “prepayment penalty”.
- “No usage fee” might be applied if the borrower never actually takes out money from the line of credit.
- Account maintenance / check-writing fees exists
- Minimum withdrawal fee might be charged by some lenders if one does not take out the minimum amount. This varies by lender.
To provide a ballpark number, for a $150,000 HELOC, costs may be $1,500 - $2,000. It is generally accepted that for short-term loans, HELOCs are more cost effective than reverse mortgages, especially for loans of between 3-5 years.
Seniors with good credit should qualify for a HELOC interest rate that is near the prime rate. The balance on a HELOC can change daily as borrowers draw funds or make payments. Therefore lenders calculate interest daily.
How to Apply
One can apply for a home equity line of credit online or at almost any bank. Many people find it of value to complete a loan application with online with a loan consolidator as these applications rarely take more than five minutes to complete and require no commitment from the borrower. Another benefit is they will generate multiple loan offers that are easily compared. Even if one is not ready to take the loan, completing the application, helps the individual be better informed when they are ready to make the decision.