Home Equity Conversion Mortgage

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21 Aug, 2024

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A home equity conversion mortgage or HECM is a reverse mortgage enabling individuals aged at least 62 years to avail of a loan based on their home equity. It allows senior citizens to convert their home equity into cash without needing to pay it back until they move or pass.

This Federal Housing Administration (FHA) insures the mortgage. The amount an individual can borrow depends on the home’s appraised value. Moreover, it is subject to the FHA limits. Such a mortgage benefits senior citizens who do not have adequate funds to make payments periodically and fulfill their loan obligations.

What Is A Home Equity Conversion Mortgage (HECM)?

The home equity conversion mortgage( HECM) refers to a reverse mortgage offered by HUD-approved lenders allowing individuals aged a minimum of 62 years to convert the equity in their primary residence into cash.
Borrowers can utilize the amount to supplement their income during retirement.
Individuals must meet the eligibility requirements for a home equity conversion mortgage. For example, the property must be their primary residence, and they must not have delinquency on any federal debt.
A key advantage of a home equity conversion mortgage for seniors is that lenders do not consider a borrower’s credit score to determine eligibility.

How Does A Home Equity Conversion Mortgage Work?

The home equity conversion mortgage refers to a government-insured reverse mortgage product that enables senior citizens to get a loan based on their home equity. This mortgage can supplement an individual’s earnings during retirement. In addition, it has no end-use limitations; senior citizens can use the amount to meet the expenses of a vacation or pay medical expenses.

Borrowers can avail of such loans via lenders approved by the U.S. Department of Housing and Urban Development or HUD. Also, one must remember that individuals can get a loan against non-residential and residential properties. The interest on such loans accrues on the outstanding balance. However, borrowers do not have to repay the amount until they sell the property, move out, or are deceased. That said, once any of such events occur, the loan must be repaid fully.

If individuals get approval for this type of mortgage, the loan amount will depend on a combination of the following factors:

The age of the youngest borrower
Current interest rate
The equity in the home

They can start repaying the amount during the loan term. However, it is not mandatory. The borrowers can decide to receive the loan amount in the form of a credit line, in a lump sum, or via monthly payments. If individuals decide to receive the HECM proceeds every month, the outstanding loan balance will rise every month. If a person selects a credit line, the mortgage will come with an adjustable interest rate. In this case, the outstanding loan balance increases whenever the borrower withdraws money from the credit line.

If borrowers do not choose to make payments, the accruing interest gets added to the outstanding balance, and the loan is repaid when the transfer of home ownership occurs. This means the borrower’s estate pays off the outstanding loan balance after their demise.

Requirements

There are certain eligibility requirements for a home equity conversion mortgage that borrowers must fulfill. Let us look at them.

An individual’s age must be a minimum of 62 years.
The person must have paid a major portion of the home’s purchase price, or the individual must be the property’s owner.
Borrowers must use the home as their primary residence.
The senior citizen must have adequate equity in the property.
Individuals must be able to participate in a HECM counselor’s consumer information session.
Borrowers cannot be delinquent on federal debt.
Individuals must be financially capable of paying the current property charges, for example, the homeowner association fees, insurance, property taxes, etc., in time.
In addition, the property must fulfill every FHA requirement and be a single-family unit or a home of 2 to 4 units where the borrower must live in any 1 unit.

All borrowers must complete the HECM application to become eligible for this form of financial assistance. Before initiating the application procedure, homeowners must meet a counselor to obtain information regarding risk, payout, alternative credit solutions, and cost.

Examples

Let us look at a few home equity conversion mortgage examples to understand the concept better.

Example #1

Suppose Jason had a home worth $500,000 and a mortgage with an outstanding balance of $30,000. A HUD-approved loan provider determined he was eligible for a HECM of $300,000. The reverse mortgage paid off the existing mortgage, and Jason could use the remaining amount to fund the home improvement expenses and meet the cost of medical treatment. He did not repay the loan. However, the interest due on the amount increased the outstanding balance over time.

Example #2

In November 2022, the FHA announced that it granted two partial waivers temporarily to its loss-mitigation policies concerning a home equity conversion mortgage. It also added that both waivers would continue the exact flexibilities specified in their previously-announced waivers dated 16 June 2022, which expired on December 31, 2022.

The two waivers would offer flexible mortgages, helping senior citizens with HECMs who still face significant financial challenges due to the COVID-19 pandemic.

Pros And Cons

There are various advantages and disadvantages of a home equity conversion mortgage. Let us look at them.

Pros

As noted above, this loan does not have end-use restrictions. Therefore, individuals can use the amount to fulfill different purposes, for example, debt consolidation and meeting medical expenses.
Individuals’ credit score is not one of the factors determining HECM eligibility.
Borrowers do not need to make monthly mortgage payments. However, they must keep paying their homeowners insurance and property taxes.
Since FHA insures this reverse mortgage product, borrowers are safeguarded from falling home values.
Individuals availing of this loan continue to remain their property’s owner.

Cons

Typically, HECMs come with higher fees than conventional mortgages.
The senior citizen’s heirs lose the property if the loan amount is not repaid.
Most of these loans come with a variable interest rate. As a result, the cost of borrowing can increase.
The interest fee rises as an individual borrows more.
Until the borrowers pay off the interest, they cannot claim a tax deduction against it.
The upfront charges can be high.

Home Equity Conversion Mortgage vs Reverse Mortgage

The concepts of HECM and a reverse mortgage can be confusing for individuals new to the world of finance. That said, one must know their distinct features to avoid confusion and fully understand their meaning. So, let us look at the critical differences between them.

Home Equity Conversion Mortgage	Reverse Mortgage
This is a specific type of reverse mortgage, which is insured by the government.	The government does not insure reverse mortgages other than HECM.
Since it is government-backed, the interest rates are usually lower than private reverse mortgages.	The interest rates are usually higher.
It does not have end-use restrictions.	Reverse mortgages other than HECM may come with end-sue restrictions.

Frequently Asked Questions (FAQs)

1. Is a home equity conversion mortgage a good idea?

A HECM is a suitable form of financial assistance for retired individuals who do not have substantial investments or savings but have significant equity in their homes. It allows individuals to turn an illiquid asset into cash to meet different expenses during retirement. Hence, retirees who wish to supplement their earnings may consider applying for a HECM.

2. What is the maximum value for a home equity conversion mortgage?

In the case of this FHA-insured reverse mortgage product, the maximum reverse mortgage limit that individuals are eligible to borrow against is $1,089,300. This amount is the ceiling, even if the home’s appraised value is higher.

3. What is the home equity conversion mortgage 95% rule?

According to the rule, if the outstanding loan balance exceeds the property’s worth, the heirs or estate may sell the home for a minimum of 95% of the property’s current appraised value. The loan provider considers the net proceeds as the full repayment.