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Home Equity Conversion Mortgage (HECM): What To Know

HECM: HUD Reverse Mortgage

A home equity conversion mortgage (HECM) is better known as a reverse mortgage. It’s designed to help eligible seniors convert their home equity into reliable streams of cash during their retirement years. Although a HECM is a loan, it doesn’t look anything like the mortgages most people use to buy their homes. On top of that, HECMs are heavily advertised products. Between those two factors, HECMs can be confusing, and many people misuse them.

What is a home equity conversion mortgage?

A home equity conversion mortgage (HECM — also known as a reverse mortgage) is a loan guaranteed by the Federal Housing Administration. Unlike “forward” mortgages, reverse mortgages do not require monthly payments. As long as you keep your home in good repair and continue to pay your property taxes, homeowners insurance and any association dues, you can continue to live in your house. Interest and fees on the loan will accrue until you sell the house or until both partners die and the house passes into your estate. At that point, the balance of the reverse mortgage must be repaid.

The balance includes any amount you borrowed, plus the cost of interest and fees. Lenders are careful not to lend more than your house is worth, but if the reverse mortgage debt is greater than the value of the house, you (or your estate) will not have to pay the difference.

Important features of a reverse mortgage

Non-recourse loan. A HECM is a non-recourse loan. That means if you end up owing more on the loan than your house is worth, you (and your estate) do not have to pay the difference.

No payments. “Forward” mortgages (what you might think of as regular home loans) require borrowers to make monthly payments on their loans. You don’t have to make payments on a reverse mortgage. As long as you live in your house, you will not have to pay a penny toward the mortgage.

Repay when you sell, move out or die. Unlike most mortgages, a reverse mortgage doesn’t have a set term. You or your estate will repay the entire mortgage balance if you sell the home, you move out of the home, or when you and your spouse die.

Could be an adjustable interest rate. Reverse mortgages can be fixed- or adjustable-rate mortgages (ARMs). If you opt for an ARM, the interest rate on the loan can change as often as every month. The interest rate on a reverse mortgage cannot increase by more than 5 percentage points over the life of the loan.

Fixed-interest reverse mortgages are available for some borrowers.

Subject to loan limits. The exact amount you can borrow on a HECM depends on many factors, including the value of your home, your age and interest rates. But the amount you can borrow with a HECM will never be more than $679,650. If you think you can qualify for a larger reverse mortgage, you’ll need to consider a jumbo reverse mortgage.

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6 payment plans for HECMs

As a reverse mortgage borrower, you can access funds from the HECM using six different payment plans, which we explain below. Before deciding on a payment plan, you should consult with a Department of Housing and Urban Development (HUD) counselor and a trusted financial adviser to decide which plan makes the most sense for you.

  • Single lump sum. If you want to use a reverse mortgage to pay off an existing loan or to buy a new house, you may take the HECM payment as a single lump sum. All single lump-sum payment plans must have a fixed interest rate.
  • Tenure. You’ll receive equal monthly payments as long as at least one borrower lives in the property as a primary residence.
  • Term payments. You’ll receive equal monthly payments for a fixed period (for example, five or 10 years). As a borrower, you get to decide how long you’ll receive the payments. A shorter time frame for receiving payments generally means you’ll get a larger monthly payment.
  • Line of credit. After taking out the reverse mortgage, you can take payments when you want, until the line of credit is exhausted. If you don’t use your entire credit limit, your available line of credit could grow over time, based on your interest rate and mortgage insurance premium.
  • Modified tenure. You can receive smaller scheduled monthly payments for as long as you remain in the home. In exchange for the smaller scheduled payments, you can keep the rest of the HECM loan limit available as a line of credit.
  • Modified term. You can receive scheduled monthly payments for a fixed time and keep the rest of your loan limit available as a line of credit.

As a borrower, you may change the payment plan for your reverse mortgage anytime, but the total loan amount cannot exceed the principal limit set by the lender.

How to use a reverse mortgage during retirement

Many boomers approaching retirement age come into retirement with their house as their largest asset. Since reverse mortgages allow seniors to turn their home equity into cash, the loan can make sense in a variety of situations.

Jason Parker, a certified retirement financial adviser and founder of the Retirement Budget Calculator, told LendingTree: “My clients taking out a reverse mortgage come from a wide swath of backgrounds. It’s not just people who need to tap into their equity as an asset of last resort.”

These are a few common ways to use the funds from a HECM:

  • To pay off existing mortgages. When you use a reverse mortgage to pay off an existing mortgage or home equity line of credit, you eliminate your housing payment during retirement. Eliminating this expense can dramatically improve your cash flow during retirement. “Funding retirement is an exercise in cash flow planning,” Parker explained. “When you can get rid of your housing payment — as long as you continue to pay insurance and property taxes — you’ll be able to remain in the house.”
  • To buy a retirement home. Instead of paying all cash for a retirement home, many seniors can use a HECM to cover part of the purchase. When purchasing a home with a HECM, you’ll need to come up with a large down payment from the sale of an existing home or from your savings. But the reverse mortgage covers the other part of the purchase. By using a reverse mortgage for a house purchase, you’ll eliminate your housing payment during retirement, and you won’t have to completely drain your nest egg to do it. John Ross, an elder attorney with Ross & Shoalmire based in Texarkana, Texas, told LendingTree, “In my experience, the folks that use a reverse mortgage most successfully tend to be people who can use the reverse mortgage for purchase.”
  • To cover emergency expenses during retirement. A reverse mortgage can be taken as a line of credit. Home equity can be especially powerful to cover emergency spending when you have few other financial resources. In particular, Parker tells clients to look into a reverse mortgage when “they’ve depleted other assets, but they want to remain in their house.”
  • To cover long-term care expenses. If a couple hasn’t purchased long-term care insurance, covering long-term care expenses can be a real challenge during retirement. “In some cases, a couple may want to use the funds from a reverse mortgage to pay for long-term care,” Parker told LendingTree. “The reverse mortgage allows a well spouse to stay in the house while paying for the care for the spouse in need of assistance.”

Who shouldn’t take out a reverse mortgage?

Taking out a reverse mortgage is a huge decision. Before you take one out, you need to consider your options. Even if you qualify for a reverse mortgage, it may not be the best decision for you.

People planning to invest the proceeds. You can use the proceeds from a reverse mortgage for almost any purpose, but Parker advises borrowers not to use a reverse mortgage to invest or purchase life insurance products. If you want to use a reverse mortgage to extend the life of your nest egg, you should work closely with a financial planner. A planner (who doesn’t sell reverse mortgages) can help you decide when to open the reverse mortgage, and when to draw funds from it.

People who want to pass the house on to heirs. When you take out a reverse mortgage, you’ll slowly lose equity in your house. Your children will have to pay off the reverse mortgage to keep the house, but there’s no guarantee that your children will have the financial resources to do so. People who have owned a house for generations should avoid a reverse mortgage if they want to pass on the home.

People who can fund their expenses through entitlements or other sources. Even if your retirement accounts are depleted, turning to a high-cost reverse mortgage doesn’t always make sense. Before opting for a reverse mortgage, Ross helps clients consider: “Are there other ways to get funds [you] need? [You] might qualify for veterans benefits or Medicaid benefits.” In some cases, loans such as a HELOC or home equity loan may be a better choice.

What are the biggest risks to taking out a reverse mortgage?

Although a HECM has built-in safety nets for borrowers, it’s not without risks. These are some of the biggest risks associated with a reverse mortgage.

High costs. When you open a reverse mortgage, you’ll pay an initial mortgage insurance premium (2% of the loan value), a loan origination fee (up to 2% of the loan value) and closing costs. These costs can add up to thousands or even tens of thousands of dollars, and that’s before you’ve even started borrowing money. Interest charges, ongoing mortgage insurance and service charges will eat into your home equity quickly.

Rising interest rates. Many reverse mortgages are adjustable-rate loans. That means the interest rate on the loan may increase. That means you’ll lose equity in the home even faster. “You want to be cautious about taking on an ARM in a rising interest rate environment,” Parker told LendingTree. “If at all possible, I want my clients to consider the fixed-rate option.”

Losing all equity in the house. Although you (or your heirs) will never have to pay more than you owe on a reverse mortgage, you may lose all your equity in your home. This is particularly common when real estate prices fall or you live much longer than expected. If leaving an inheritance to your children is very important, the reverse mortgage may not make sense for you.

Reverse mortgage FAQs

Do I need a paid-off house to take on a reverse mortgage?

You don’t need a paid-off house to take out a reverse mortgage, but you do need substantial equity to qualify for a HECM. The exact percentage of equity you need depends on the interest rate environment and your age.

Who is eligible for a reverse mortgage?

HECM qualifications
Age requirements 62 years and older (both spouses must be at least 62)
Minimum credit score No credit score underwriting
Other credit considerations Disqualified if:

  • Have delinquent federal debts
  • Delinquency on HUD-insured loan in the past three years
Income requirements Your lender will verify that you have the necessary income or assets to pay for maintenance, property taxes, insurances and other necessary expenses.
Loan counseling Must undergo HECM loan counseling before borrowing
Home requirements Must be primary residence

Single-family home or must live in one unit of a two- to four-unit multifamily property.

Condominiums must be approved by HUD.

Manufactured homes must meet FHA requirements (including foundation requirements).

 

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How can I use the money from a reverse mortgage?

The FHA does not place any limits on how you can use the funds from a reverse mortgage. But if you have a mortgage, HELOC or home equity loan on your property, you may have to pay it off with the proceeds of the reverse mortgage.

Borrowers can opt for their reverse mortgage lender to set up an escrow account to pay insurance and property taxes. In that case, the lender will always pay for those expenses from the reverse mortgage.

Will I be able to pass my house on to my children?

When you take out a reverse mortgage, you no longer own your home free and clear, but your name will stay on the title of the home. That means when you die, the home will pass into your estate. Most of the time, your heirs will sell the house to pay off the mortgage balance.

If your children wish to keep the house, they can pay off the mortgage balance using a new loan or other financial assets. If the reverse mortgage is worth more than the house, your children can buy the house from the estate for 95% of the fair market value of the house.

Will I owe taxes on the reverse mortgage?

The proceeds from a reverse mortgage are loan proceeds, so they are not taxed as income. When selling your house, you may have to pay capital gains taxes based on the increase in the home’s price.

How much can I borrow with a reverse mortgage?

The amount you can borrow depends on the value of your home, your age and the interest rate on the reverse mortgage. Older couples, borrowers with lower interest rates and borrowers with higher home values can borrow more.

For example, a 62-year-old couple with a $500,000 home can borrow up to $228,500 on a 7% loan. An 82-year-old couple with a $250,000 home can borrow up to $175,00 on a 7% loan. If borrowers are not the same age, the age of the youngest borrower is used to determine loan limits.

The maximum you can borrow is $679,650.

What happens if my house ends up underwater?

HECM reverse mortgages are designed to protect seniors who use them. If you owe more on your reverse mortgage than your house is worth, you can continue to live in your house. Additionally, you will never have to pay more than your house is worth.

Should I only take out a reverse mortgage if I’m facing financial trouble?

Financial emergencies are not the only reason to consider a reverse mortgage. “I have many high-net-worth clients who use the reverse mortgage to buy their dream retirement home,” Parker told LendingTree. “It allows them to maintain liquid assets (cash) and keep their retirement expenses low.”

Before taking out a reverse mortgage, most people should consult with a trusted financial adviser who doesn’t sell reverse mortgages.

Can I lose my house if I have a reverse mortgage?

Your lender cannot foreclose on you if you owe more than your house is worth, but that doesn’t rule out all foreclosures. For example, you may lose your house if you do not pay property taxes, homeowners insurance or homeowners association dues.

How much does a HECM cost?

The interest rate on a reverse mortgage will depend on the type of loan you take out (fixed interest or adjustable rate) and the prevailing interest rate environments. To get an estimate on your rate, you can use this calculator from the National Reverse Mortgage Lenders Association.

But the mortgage interest rate is just one cost to consider. As a borrower, you’ll pay an ongoing annual mortgage insurance cost (0.5% of the amount you’re approved to borrow) and servicing charges of up to $35 per month. Plus, when you take out the loan, you’ll pay the loan origination fee (up to 2% of the amount you’re approved to borrow) and the initial mortgage insurance premium (2% of the amount you’re approved to borrow).

Altogether, the costs of a HECM can be hefty, especially compared to other types of loans such as a HELOC or home equity loan. Of course, those loans require ongoing payments and do not have the protections of a HECM reverse mortgage.

How to find a reverse mortgage (HECM)

Reverse mortgages are heavily advertised, so it’s easy to find one, but borrowers shouldn’t rush into a loan. Even if the loan is legitimate, it may not be the best tool for your financial situation. For example, the Consumer Financial Protection Bureau warns that some seniors feel pressured to take out a reverse mortgage when their homes need repairs. Seniors facing mounting medical costs may also take out a reverse mortgage before considering whether those costs could be covered through other means. Most seniors should consider other funding options for their needs (such as retirement accounts, Medicare or veterans benefits, Social Security income and more) before opting for a reverse mortgage.

Before shopping for a reverse mortgage, you’ll need to consult with a HECM counselor to learn about the implications of taking out a reverse mortgage. You may also want to talk to a trusted financial planner before taking out the loan.

Once you’re certain that you’re a good candidate for a reverse mortgage, it’s time to shop around. It’s always a good idea to ask a trusted financial adviser to help you find a good HECM lender. You can also potentially compare several reverse loan offers at once on LendingTree. This will allow you to review rates and terms from several lenders so that you can choose the option that best suits your needs. After narrowing down your search to a few lenders, you’ll want to speak with a loan officer from each company. The loan officer should communicate clearly with you and help you understand the risks and benefits of a reverse mortgage.

 

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