Future SHOCK for Older Homeowners: You Won’t Get a HELOC, a Second, or Refi based on your Equity
There’s something I’ve come to realize many people don’t know: Mortgage lending in this country has changed dramatically. Today, it’s much harder for people to get mortgages in general, and for those lacking actual income, it’s become impossible.
Many saw the story on Bloomberg.com about a week ago about former Federal Reserve Chairman Ben Bernanke admitting that he had been turned down recently when applying to refinance the mortgage on his Capitol Hill home that he and his wife purchased back in 2004.
Everyone seemed surprised to hear it… but I wasn’t. He’s retired, after all. So, obviously, his income has dropped significantly… why would he think he’d qualify for a mortgage? All Bernanke’s tale of denial did for me was reinforce how out-of-touch the Fed Chair has been and is, as related to the mortgage meltdown and housing crisis in this country. He obviously just doesn’t get it at all.
Some point out that he’ll be getting $250,000 per speech, and that might be relevant if he had actually spoken a few times and put a few of those quarter of a million dollar fees in his bank account, but even then, how does the bank know that those speaking fees will hold up over the years to come.
Others pointed out that he got a $1 million book advance, but isn’t an advance a liability until the book’s done and the advance becomes earned? And an advance like that isn’t likely to happen again, right? It’s hardly something to be classified as regular income by today’s standards.
And Bernanke isn’t alone, by the way. He’s not the only senior level government official to discover the reality of lending in America today.
Last week on Bloomberg TV, Alan Krueger, former chairman of the Council of Economic Advisers to the President, admitted that he too was recently turned down for a mortgage on a second home, even though he was offering to put 50 percent down!
Krueger, at least, has a job. He is currently employed as a professor of economics and public affairs at Princeton University, so he’s got income, but it obviously it wasn’t enough, especially because the property was to be a second home. Banks learned the hard way this last time around, that when money gets tight, people walk away from second homes without nearly the hesitation of a primary residence, so they’re reluctant to finance them…. for anyone, apparently.
The reality is that with the private RMBS securitization market still largely frozen, government lending essentially the only game in town, the prevalent and entirely reasonable fear of “buy backs” among bankers, actions by the Consumer Financial Protection Bureau (CFPB), Dodd-Frank’s impact, new QM rules, and whatever else you’d want to throw in under the category of new and increased pressures on lenders… it should not be a surprise that loans are harder to come by than at any time in recent history.
Today, your assets don’t matter when applying for a mortgage… only the amount of income you earn is considered when assessing your ability to repay the loan. That means that today, the fact that you own a home free and clear that’s worth $1 million, by itself, is not going to get you approved for a Home Equity Line of Credit (HELOC), second mortgage or refinance.
Today, to get approved for a HELOC, or a second home, not only do you need significant equity, but you’ll also need actual income that’s deemed sufficient to repay the loan… and a glimmering FICO score… like we’re talking 760+… that sort of thing.
The fact is that the small number of HELOCs being approved today is considered “pristine credit risk,” and the volume of these loans being approved is about 90% lower than in 2006. The days of being able to get a HELOC while on your lunch break simply because you had equity in your home are long gone, and there’s no reason to think they’ll be back anytime soon… at 53, maybe not in my lifetime.
The resulting problems faced by those in their 60s, 70s and 80s should be obvious…
The older we get the less income we tend to earn, and when we hit a bump in the road our expenses can rise as our incomes fall. It doesn’t take much to throw someone of course during retirement, because they can’t recover simply by bringing in more income, like they were able to do during their working years.
That’s the sort of moment when, in the not so distant past, like 2005 or even 2006, you could get a HELOC, and use that money to get through the bump in the road. But, when you combine today’s changes to lending with the realities of getting older, you realize we won’t be able to get those loans, unless we have the income required… not the assets, the income.
And that means that when you need the money during your retirement years, because something unexpected caused your income to drop, your expenses to rise, or both… you’ll find that your equity is essentially buried in your back yard… and buried deep. So deep, in fact, that you won’t be able to access it until you sell the house, which is something you may not want to do.
So, even though you might have hundreds of thousands in equity, without the actual income needed to repay a $100,000 loan, you won’t be able to get that $100,000 loan.
This new reality could lead one to thinking that they should go get that HELOC now, before they hit that bump in the road that lowers their income, but it’s not enough protection… and it’s a bad idea besides.
First of all, HELOCs are loans that require the borrower to make interest only payments for 10 years, after which time the loan becomes fully amortizing, meaning you start making payments of principal and interest, which means your payments jump up by several hundred dollars or more at the end of year 10.
Since the probability of your income dropping goes up as you get older, taking out a loan at 65, whose payment increases in 10 years… when you’re 75… is simply a recipe for disaster.
The other problem with HELOCs is that banks can reduce or cancel them pretty much whenever they choose to do so. Yes, there are some rules and guidelines, but in 2008 and 2009, thousands learned about this reality the hard way during the mortgage meltdown when their home’s value fell and their banks canceled their HELOCs unilaterally, simply by notifying them by mail.
FROM A POST IN 2008… Over the past four months, we’ve been keeping a list of major lenders sending out home equity line freeze letters. To date, an estimated 400,000 HELOC freeze notices have been sent and we receive information about new line freezes almost weekly. Here’s the latest update.
Lenders Freezing Home Equity Lines of Credit
Countrywide (recently froze almost all HELOCs in Las Vegas)
Washington Mutual (sending more letters this week)
Capital One (Greenponing Mortgage Unit)
Bank of America
USAA Federal Savings
It’s important to note that these lenders are not freezing all of their customer’s HELOCs. Certain customers are receiving freeze notices when the lender determines that their property value has declined. The value is generally based on the lender’s AVM (automated valuation model) and not a physical appraisal.
Some mistakenly believed that the HELOC freeze would end in January. However, borrowers are still receiving notices. Since property values are continuing to decline, it is safe to assume that the HELOC freeze will continue.
Retirees don’t need potentially disappearing credit lines… they need access to money they can count on to be there when they need it. And they certainly don’t need loans with payments that jump up as they get older.
For those two reasons it may actually be a good thing that you wouldn’t qualify for a HELOC at the point you needed one during retirement, and they are also reasons why getting a HELOC before you retire wouldn’t provide the sort of financial safety net you want and need during your retirement years.
And even if those two things didn’t apply, having payments that increase in 10 years is just a bad idea for people whose income is likely to fall, or whose expenses are likely to rise, during those same ten years.
The only exception to all of this would be found when talking about a “hard money loan,” but those are not loans anyone wants. Hard money loans are a necessary evil. They’re offered at comparatively high rates, like today you’d find the average to be around 12 percent, and because they’re exempt from many regulations they can impose all sorts of undesirable terms. Most if not all would agree that they are to be avoided if at all possible, and even more so by retirees.
So, understanding that your home equity will essentially be buried deep in your back yard until you sell the home, how much do you want buried down there?
This is the sort of question to which there is no right or wrong answer, but I’m going to share the various considerations you might take into account when developing your own answer.
For example’s sake, we’ll say my home is worth $400,000 and I either own it free and clear, or have 50 percent equity.
Okay, first of all, I think keeping 100 percent of the $400,000 in equity buried deep in my yard is too much. It represents too many eggs in a single basket, for one thing. And for another, since I realize that my life expectancy at 65 is roughly 20 years, I think I’d like to be able to access some of that equity in an emergency, without being forced to sell my home or get a hard money loan.
I think I’d settle at around 30-50 percent to stay conservative. I think having 50 percent equity is enough protection against a downturn in home prices, because it would have to fall more than 50 percent to prevent me from being able to sell it, and that seems highly unlikely from where we are today.
I also am willing to assume that my home’s value in the 10 years ahead, although it may not go up like it used to, will increase by at least two percent a year… maybe even three or four… but definitely two.
That means I’m comfortable planning based on my $400,000 home being worth roughly $500,000 at the end of 10 years worst case. If it increases in value by four percent a year, it’ll be worth $600,000 at the end of year 10.
So, if I could hold back $200,000 of my current equity of $400,000, from being buried deep in my yard, it might be a prudent idea… just in case I need access to extra cash sometime in the next 20 years, since I won’t be able to access it otherwise once it’s buried.
At the very least I would hold back $100,000. I might not need it now, but that’s just not the point. We should all know that we don’t know what will happen to us between age 65 and 85, we just know something could happen at any moment during those years that could leave us needing extra funds, whatever it might be.
Remember… it’s not the things we can imagine coming at us that are likely to cause us the most harm. It’s the things we previously could not have imagined that we have to worry about. Like the tsunami that hit Thailand a few years ago… if they had known it was coming it probably wouldn’t have left hundreds of thousands dead.
It’s the surprise part that’s deadly, so the fact that you can’t imagine what could happen isn’t a reason not to be as prepared as you can for the dangerous unknown that is sure to come as a surprise. (I recently wrote about this reality here: “Understanding The Black Swan – Thy Name is Retirement.”)
In other words, holding back $100,000 to $200,000 out of $400,000 in equity from being buried out of reach for 10 or more years, is not a bad idea, especially because in 10 years, you could expect the amounts held back to have been replaced by a 2-4% annual growth in the home’s value.
To my way of thinking, it’s not risky to have a line of credit available… it’s risky not to have one.
Today, the fact is… there’s ONLY ONE WAY to accomplish this goal.
You don’t want to learn the hard way that it’s difficult or even impossible to access the equity you have in your home, especially if you’re still paying off a mortgage, as some 40 percent over 65 still are, according to the latest census data.
The only tangible benefit to owning your home free and clear in retirement is that you can live in it for the rest of your life without having to make monthly mortgage payments. That’s it, nothing else.
What if there was a way to convert some of your equity to cash, when you needed to… but didn’t have to worry about having to paying the money back… and you could still stay in your home for life without having to make payments on the amount you borrowed.
It’s like borrowing money “on the house,” if you appreciate exquisite double entendre.
Don’t get me wrong… you could pay the loan off if and when you wanted to, but the point is that you wouldn’t have to. You could elect that the loan is to be repaid either when you sell the house, or by your heirs after both yours and your spouse’s death, when they either sell or refinance the property.
The type of loan I’m describing is only available to those over 62 years of age, and It’s called a Home Equity Conversion Mortgage. It’s a program created by congress, regulated the U.S. Department of Housing and Urban Development (HUD), and insured by the FHA. And if you’re approaching or already in retirement, it’s important that you gain an accurate understanding of how this specially designed mortgage can work for you.
The HECM loan is just like any FHA loan, except that it offers homeowners over age 62, the ability to convert some portion of their equity into cash, or credit line, so it’s there when you need it, and because it offers the most flexible repayment terms imaginable. You can choose to make interest only payments, or principal and interest payments, or no payments at all. And you can choose one option, but change to another at anytime you desire.
In its simplest terms, it’s a loan you don’t have to repay until after your death from the sale or refinance of your home by your heirs. Repay it, or don’t. It’s all your call.
And it’s also a loan you can qualify for, assuming you’re 62 and you have sufficient equity in your primary residence. That’s it. There’s no credit score or income requirement to qualify. And the bank can never cancel it… the credit line is yours for life, guaranteed.
Some have suggested that there’s some sort of stigma attached to using a HECM loan, which I have to say, struck me as odd, since to be able to use a HECM you have to have a significant amount of equity in your home.
It’s sort of funny that for the last five years I’ve been writing about why homeowners who are underwater and at risk of foreclosure shouldn’t worry about any sort of stigma attached to their situations because what they’re facing can happen to anyone who’s underwater. And now apparently there’s also some sort of stigma attached to having a lot of equity and using a HECM as a line of credit?
I think some homeowners should get over themselves. Why would anyone care about what a loan is called anyway? I never even knew what my loan’s name was, or if it even had one. It’s not like I wear my loan’s logo on my golf shirt or anything like that.
“Hi, I have a HAMP.”
“Oh, really, I have a HARP.”
“Well, I’m Fannie Mae exclusively.”
“Jim just turned 62 so this time we were able to go with the HECM.”
“We moved to Indiana and got an USDA. We call it our Us•Duh.
Pretty ridiculous, if you ask me. Do you think large corporations would think twice if they could borrow funds with the same terms as are offered to homeowners over 62 by the HECM program? Do you think they’d worry about some supposed stigma? Not likely.
Big corporations know that money doesn’t come with stigma. Money is just money. And it’s a government program loan, just like all the other loans available today like Fannie, Freddie, VA, USDA, FHA… in fact, something very close to 99 percent of the loans today are government loans. The banks certainly don’t seem to mind loans made possible by government programs, I can’t imagine why homeowners would.
The bottom-line that older homeowners need to know…
The bottom-line today is that if you’re over 62 and still have a mortgage payment, you have to ask yourself what you’d do in the event your income dropped or your expenses rose unexpectedly? You can spend your savings to make the payments, but it’s not something you want to do because spending your nest egg can lead to you running out of money before reaching your life expectancy.
But you need to know that it’s highly likely that you won’t be able to qualify for a HELOC or second on your home at the point that you need one, because you won’t have the income at that moment in time, and the amount of equity you have won’t do it. That’s not the way it used to be, but it’s the way it is today.
The HECM offers other advantages as well. For example, the amount of your line of credit is guaranteed to increase by the amount of the interest rate every year you don’t access the funds, so if the interest rate were 5 percent, the amount you could access would increase by 5 percent a year… regardless of whether your home’s value went up or not. That means it’s also a hedge against your home’s value declining in the future, and there’s no other loan that will do that.
By 2011’s end, 1.5 million homeowners over 65 had already lost homes to foreclosure, and as of today we’ve lost something in the neighborhood of three million homes among those in that age group. The reasons should be self-evident.
We should all come to terms with the fact that as we get older our incomes fall and our expenses rise… not for everyone and not all at once, but often enough. And when that happens, it’s always a problem.
Many people at age 75 or beyond have income that only consists of Social Security, even though they might also have $500,000 in home equity and $1 million in the bank. The last thing you want to be forced to do is spend that $1 million nest egg… or be forced to sell your home… and having a HECM line of credit can protect you against the risk of something happening that forces you to do either.
Times have changed and mortgage lending has changed dramatically. It’s crucial that older homeowners gain an understanding of what’s changed now… before they’re shocked by what they can’t do in the future. And don’t listen to those who say the HECM line of credit is expensive… it’s just not. The fees are capped by HUD, and I don’t think you’ll find it much more expensive than any other type of loan, if at all.
(And, because it’s FHA insured, you can never owe more than the home is worth… never. How many people would have wished for that sort of provision these last few years. In case you haven’t already caught it, here’s a link to a Mandelman Matters Podcast with Dr. David Johnson, a university professor who has extensively researched and published academic papers on the subject.)
I’m publishing a free e-book on this and other important topics for retirees, and you can order it now by emailing me at: Mandelman@mac.com.
Just send me your email with the subject: FREE RETIREMENT E-BOOK and you’ll receive “The Top 25 Mandelman Matters Articles on Financing Your Retirement,” that includes over 150 pages packed with invaluable information about getting through your retirement years… information that you won’t find anywhere else, and certainly not in any one place. (Send your e-mail today to receive this e-book free, because it will only be available free for a limited time.)