Definition and Examples of Home Equity Conversion Mortgages (HECMs)
Borrowers can apply for a HECM through banks that offer them and are approved by the Federal Housing Administration (FHA). Applicants are required to receive counseling from an approved counselor to learn more about these mortgages as well as their other options.
HECMs are intended as a way for seniors who have little or no income and very few assets to derive an income from the equity in their home.
Let's say you have a home worth $400,000 and an existing mortgage with $25,000 remaining. Your lender determines you can get a HECM for $300,000. The HECM pays off your existing mortgage and you get a lump-sum payment for the remaining amount.
You can then invest the $275,000 or simply withdraw the amount you need each week. Over time, the interest due on the loan will increase the principal balance.
How Home Equity Conversion Mortgages (HECMs) Work
If you’re approved for a HECM, your loan amount is determined by a combination of the amount of equity in your home, the youngest borrower’s age, and the current interest rate. Although you can choose to make payments during the term of the loan, you do not have to.
You can choose to receive your HECM proceeds in a lump sum, in monthly payments, or as a credit line. If you choose to receive the amount in monthly payments, the balance on the loan will increase each month. If you choose a credit line, the loan will have an adjustable interest rate and the balance will increase whenever you draw money from it.
If you do not make payments, the accruing interest is added to the loan balance and the loan is paid off when the home changes ownership. That means your estate will pay the loan off when you pass away or if you sell the house, the loan will need to be paid off then.
Once you secure a HECM, you have to continue making property tax payments, keep the home insured, and take care of it.
HECMs can be problematic if the rate is high or if you only qualify with an adjustable rate. If you choose not to make payments, the accumulated interest adds up very quickly, and by the time you want to or need to move, there could be no equity left in the property. This means reduced assets for you and your heirs later on.
You also need to consider the fees. Before you can even apply, you have to pay for the pre-HECM counseling. When the loan originates, the lender can charge an origination fee of up to $6,000. Closing costs such as title insurance, appraisals costs, inspections, and recording fees add up quickly and can end up being four, or even five, figures. The FHA also charges an upfront fee for the mortgage insurance premium (MIP).
Those are just the upfront costs. Annual servicing charges and MIP are also charged and added to the balance of the loan.
If you have a lot of equity in your home, few or no other assets, and need income or cash, the HECM may work well for you. If you have other assets you can use or a good, steady income already, consider holding off on a HECM until you need it.
How To Get a HECM
HECMs are available from the same types of bank lenders that do conventional residential mortgages. As long as a bank is approved by the FHA, it should be able to do HECMs. Visit your usual branch to see; if they do not offer them, ask for a recommendation.
The following items are the requirements to qualify:
- Pre-application counseling
- Borrower age of 62 or older
- Home used as primary residence
- Borrower approved as willing and able to make insurance and property tax payments
- Sufficient equity in the home
- Must live in a single-family home; one unit of a two- to four-unit home; a HUD-approved condominium; or a manufactured home that meets FHA requirements
- Borrower must not be delinquent on any federal debt
HECM vs. Single-Purpose Reverse Mortgage vs. Proprietary Reverse Mortgage
The HECM is one of three types of reverse mortgages. Each is used by people who have paid down most of their home mortgage or own their home outright.
Single-purpose reverse mortgages are offered by some state and local governments and nonprofit organizations. This type is less expensive than the other two, but can only be used for one purpose, like home repairs or remodeling.
Proprietary reverse mortgages are non-government-insured private reverse mortgages. These programs are offered by banks, with their own sets of terms and conditions. You may be able to find a proprietary reverse mortgage with better terms and related fees than a HECM.
The main con of many proprietary reverse mortgages is that there is no government insurance of the collateral value. If your home value goes down, you may be required to pay down the loan as well. The FHA insures HECMs so that if the home value goes down, you do not have to make up the difference.
- HECMs allow people ages 62 years or older to convert the equity in their homes to cash.
- Loan payments do not need to be made until the home is sold or the borrower passes away.
- HECMs can come with high fees and interest rates, so make sure you know the full cost.