As the fixed rate HECM has become more popular, HUD recently decided to issue guidance on the product that will require HECM counselors to highlight the risks related to fixed rate HECMs to borrowers during a counseling session. They want to make sure clients understand the following risks and considerations when opting for a fixed rate over an adjustable rate HECM.
- Rate Comparison: Fixed-rate HECMs often have loan rates considerably higher than the current adjustable rate HECM. The client’s total interest cost over the life of the loan may be considerably higher for a fixed-rate vs. an adjustable-rate HECM.
- Proceeds Comparison: Because fixed-rate HECMs generally will have higher rates, the current amount of proceeds available from a fixed rate HECM may be lower than the proceeds available from an adjustable rate HECM.
- Disadvantage of closed-end credit: Borrowers desiring a fixed-rate HECM will receive a closed-end loan. Borrowers with a closed-end loan will not be able to prepay the loan and draw any additional funds.
- Disadvantage of drawing all funds. If a borrower chooses to draw all of their funds to qualify for a lower fixed interest rate, this action may not be to their benefit. Drawing the entire loan balance at closing exposes the borrower to a number of risks, including the risk that the interest payment on the HECM loan would be greater than the interest paid by an alternative investment vehicle (e.g. interest bearing savings account). Other investment vehicles like deferred annuities do not allow the owner of the annuity to access funds for a certain length of time. So if a senior uses the HECM loan proceeds to purchase a deferred annuity, their access to these funds may be restricted for a significant period of time unless the senior pays an early withdrawal penalty. While a deferred annuity may be a reasonable option for some seniors given their specific situation, counselors should help clients understand the risks of drawing down all funds to invest in alternative investment vehicles. In addition, should a consumer need additional cash flow in the future, no additional proceeds will be available.
Thanks to Stephen Kinney for pointing this out.