Home equity conversion mortgage (HECM) guide

What is a home equity conversion mortgage (HECM)

Home equity conversion mortgages (HECM) are designed for senior homeowners age 62 and older. Unlike a traditional mortgage, where a borrower makes monthly payments to a lender, a home equity conversion mortgage allows the homeowner to convert a portion of their home's equity into cash or a line of credit, without having to sell their home or make regular loan payments.

Here's how it works: Based on the age of the youngest borrower, current interest rates, and the home's value, a maximum loan amount is determined. The homeowner can choose to receive this as a lump sum, monthly payments, a line of credit, or a combination of these options.

Over time, the loan balance grows due to interest and fees, but no payments are due until the homeowner moves out, sells the house, or passes away. That’s when the loan must be repaid, usually through the sale of the home. The homeowner or their heirs will never owe more than the home's worth, thanks to a non-recourse feature. Any remaining equity after paying off the HECM belongs to the homeowner or their heirs.

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How does a home equity conversion mortgage work?

Eligibility: The primary borrower must be at least 62 years old, own the property outright, or have a significant amount of equity in it. The home must be the primary residence.

Loan amount: The amount you can borrow is based on several factors, including the borrower's age, the home's current value, current interest rates, and lending limits.

The borrower can choose how to receive the funds, either in lump sum payment, monthly payments (for a specific term or as long as the borrower lives in the home) a line of credit, or even a combination of the above.

The loan accrues interest over time, along with any associated fees. Unlike a traditional mortgage, no monthly payments are made toward the loan balance.

Living in the home: Borrowers can continue to live in their home as long as they maintain it, keep up with property taxes, homeowners insurance, and any other related costs.

Loan repayment: The loan becomes due and payable when the last surviving borrower moves out, sells the home, or passes away. At this point, the home can be sold to repay the loan, or if the heirs wish to keep the property, they can refinance the amount owed on the reverse mortgage.

Non-recourse feature: A critical feature of HECMs is that they are "non-recourse" loans. This means if the home's value is less than the loan balance when it's time to repay, the lender cannot come after the borrower's other assets or estate for the difference. The lender is only entitled to the proceeds from the sale of the house.

How is an HECM different from other reverse mortgages?

The term "reverse mortgage" is a general description of a financial product that allows senior homeowners to convert a portion of their home's equity into cash without selling the house. An HECM is a specific type of reverse mortgage insured by the FHA. Here are the key differences between HECMs and other "normal" reverse mortgages:

Government insurance: One of the most defining features of an HECM is its government backing. HECMs are insured by the FHA, providing an extra layer of protection for borrowers. If the loan balance becomes greater than the home's value, the insurance covers the difference, ensuring that neither the borrower nor their heirs owe more than the home is worth.

Lending limits: HECMs have lending limits set by the FHA. The maximum amount one can borrow with an HECM might be lower than some private reverse mortgages.

Consumer protections: HECMs come with mandatory counseling requirements. Prospective borrowers must undergo counseling from an independent, FHA-approved counselor to ensure they fully understand the terms and implications of the loan.

Property standards: Homes eligible for an HECM must meet specific FHA property standards. Regular appraisals and inspections may be required.

In contrast, private or proprietary reverse mortgages might offer larger loan amounts or be available to younger borrowers, but they lack the government insurance and standardized consumer protections inherent to HECMs. Both options can serve the needs of seniors, but it's crucial to choose the product that aligns best with one's financial situation and goals.

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How do you get an HECM?

Obtaining a home equity conversion mortgage involves several steps. Here's a step-by-step guide on how to get an HECM:

Eligibility: Ensure you meet the basic requirements:

• You're at least 62 years old.
• The home is your primary residence.
• You either own the property outright or have a significant amount of equity in it.
• You are not delinquent on any federal debt.

Counseling: Before you can apply for a, HECM, you must undergo counseling from an independent, FHA-approved counselor. This ensures you understand the terms, costs, and implications of the loan.

Choose a lender: Research and select an FHA-approved lender. Not all lenders offer HECMs, so ensure the one you choose is reputable and provides good terms.

Application: Complete the loan application with your selected lender. They will require financial documentation, verify your eligibility, and assess the risks associated with offering you a loan.

Property appraisal: The lender will order a home appraisal to determine the current market value of your property. This will help determine how much you can borrow.

Loan terms: Review the loan terms, interest rates (fixed or variable), fees, and decide on a payment option: lump sum, monthly payments, line of credit, or a combination.

Closing: If approved, you'll proceed to closing. This is where you'll finalize the loan documents and set up how you’ll receive the funds.

Post-closing responsibilities: Remember, with an HECM, you must maintain your home, pay property taxes, homeowners insurance, and any homeowner association fees. Failure to do so can result in the loan becoming due and payable.

Who is eligible for a home equity conversion mortgage (HECM)?

Age requirement: The primary borrower must be at least 62 years old. If the home is co-owned, both owners can be borrowers, but the age of the youngest borrower will influence the loan amount.

Primary residence: The property in question must be the borrower's primary residence. This means the borrower must live in the home for the majority of the year.

Homeownership: Borrowers must either own their home outright or have a substantial amount of equity in it. If there's an existing mortgage, the HECM proceeds must first be used to pay that off.

Property types: Eligible properties include single-family homes, 2-4 unit owner-occupied dwellings, HUD-approved condominiums, and some manufactured homes.

Financial assessment: Lenders will assess the borrower's financial situation to ensure they can cover ongoing property expenses, like taxes, insurance, and maintenance.

Mandatory counseling: Before securing an HECM, borrowers must undergo counseling with an independent, FHA-approved counselor to ensure understanding of the loan's terms and implications.

Meeting these criteria doesn't guarantee loan approval, but they are the necessary prerequisites to start the HECM application process.

Home equity conversion mortgage pros and cons

HECMs offer unique financial benefits for eligible homeowners, but, like all financial products, they come with both advantages and drawbacks. Let’s look first at the pros:

Pros:

Liquidity: HECMs allow seniors to tap into their home's equity without selling, providing financial flexibility during retirement.

Payment options: Borrowers can choose between a lump sum, monthly payments, a line of credit, or a mix, tailoring the disbursement to fit their needs.

No monthly mortgage payments required: Unlike traditional mortgages, HECM borrowers aren't required to make monthly payments, though interest accrues over time.

Stay in the home: Borrowers can remain in their homes, maintaining a sense of comfort and continuity.

Non-recourse loan: The loan amount will never exceed the home's value. If the balance surpasses the value when sold, the FHA insurance covers the difference, ensuring heirs aren't responsible for the deficit.

Cons:

Fees and costs: HECMs can come with high upfront costs, including origination fees, insurance premiums, and closing costs.

Accruing interest: Over time, the loan balance grows due to accrued interest, potentially consuming significant home equity.

Impact on benefits: The proceeds might affect eligibility for means-tested benefits, like Medicaid.

Heirs' inheritance: Reduced equity means fewer assets could be left for heirs, unless they choose to repay the HECM and retain the property.

Ongoing costs: Borrowers are still responsible for property taxes, insurance, and maintenance. Failure to keep up with these can lead to loan default.

FAQ

How is an HECM repaid?

A home equity conversion mortgage is repaid when the borrower no longer uses the home as their primary residence. This can occur when they sell the house, move out, or pass away. Typically, the home is sold, and the proceeds from the sale are used to repay the HECM loan balance.

If the loan balance is less than the sale proceeds, the remaining equity goes to the borrower or their heirs. If the balance is higher than the home's value, the FHA insurance covers the deficit, ensuring no additional debt burden is passed to the heirs.

Is an HECM a second mortgage?

HECMs are not typically referred to as a "second" mortgage in the traditional sense. The term "second mortgage" usually describes a loan that is taken out in addition to a primary or "first" mortgage, with the home serving as collateral for both loans.

An HECM, on the other hand, is a type of reverse mortgage. If a homeowner already has a mortgage on their property when they obtain an HECM, the proceeds from the HECM must first be used to pay off the original mortgage. Once the first mortgage is paid off, the HECM becomes the primary lien on the property.

That said, if you're using the HECM to tap into equity beyond an existing mortgage, it effectively acts like a "second" way to borrow against the home. But in practice, it replaces any existing mortgages to become the primary lien.

Are HECMs expensive?

Home equity conversion mortgages can be perceived as expensive due to their associated costs. They come with various fees, including an origination fee, closing costs, mortgage insurance premiums, and ongoing service fees. While the exact costs depend on the loan amount and terms, the initial charges can be significant.

Additionally, because borrowers don't make monthly payments on an HECM, the interest accrues over time, increasing the loan balance. This compound interest can significantly reduce the home's equity over the years. Therefore, while HECMs offer valuable financial flexibility, potential borrowers should closely examine all costs to determine if it's a suitable option for them.

What are good alternatives to HECMs?

If you believe reverse mortgages are right for you, but question whether an HECM is the right path, consider these alternatives:

**Home equity loans: **These are traditional second mortgages where homeowners borrow a lump sum using their home's equity as collateral, repaying it in fixed monthly installments.

**Home equity lines of credit (HELOC): **A revolving line of credit based on home equity, offering flexibility in borrowing and repayment.

**Refinancing: **Homeowners can refinance their existing mortgage to secure better terms or tap into their equity.

Downsizing: Selling the current home and purchasing a less expensive one can free up equity.

Deferred payment loans: Offered by some local governments or nonprofits, these loans target senior homeowners to fund specific expenses like home repairs.