Understanding Why and How the HECM Line of Credit Grows
By Wade Pfau, The Retirement Researcher
A reverse mortgage—specifically a Home Equity Conversion Mortgage (HECM)—offers a unique feature: the effective interest rate applies not only to the loan balance but also to the overall principal limit, which grows over time. While this may sound technical, it’s a crucial concept for understanding the value of opening a HECM line of credit.
How Growth Works
In most cases, the principal limit, loan balance, and remaining line of credit all grow at the same effective rate. Although older reverse mortgages sometimes included a servicing set-aside that grew independently, today’s loans apply a consistent growth rate across all components—including any new set-asides.
The principal limit is the sum of:
• The loan balance
• The available line of credit
• Any set-asides
Interest and insurance premiums are charged only on the loan balance—not on set-asides or unused credit. However, both the line of credit and set-asides grow as if those charges were applied, which increases the total available funds over time.
When funds are borrowed, the line of credit decreases while the loan balance increases. Voluntary repayments, on the other hand, replenish the line of credit, which then continues to grow at the effective rate—potentially increasing future borrowing power.
Visualizing the Growth
Exhibit 1.1 illustrates this relationship. As all components grow at the same rate, the proportions remain constant unless additional borrowing or repayment occurs. This consistent growth expands the overall principal limit over time.
Why Timing Matters
Opening a reverse mortgage early—even without immediate use—can be a strategic move. The unused line of credit grows over time, which can be a powerful financial planning tool. This feature often surprises newcomers, as it seems almost too good to be true.
The HECM program was likely designed with the assumption that borrowers would use their credit early. In that case, growth in the principal limit would primarily reflect an increasing loan balance. However, if the line of credit is left untouched, it grows just as quickly—sometimes dramatically.
A Tale of Two Borrowers
Let’s consider two borrowers who each open a reverse mortgage with a $100,000 principal limit. Ten years later, both have a principal limit of $200,000.
• Person A withdraws the full $100,000 upfront. After ten years, their loan balance has grown to $200,000 due to accrued interest and insurance premiums.
• Person B leaves the line of credit untouched. After ten years, they now have access to the full $200,000—without having paid interest or premiums during that time.
Person B can now withdraw the full amount, effectively bypassing years of interest and insurance costs. This strategy, sometimes called the “ruthless option” by academics, can significantly benefit the borrower while posing challenges for lenders and the mortgage insurance fund.
