Reverse mortgages have become quite a popular loan product for senior homeowners in recent years. In case you weren’t familiar with the term, a reverse mortgage is when mortgage payments don’t flow from borrower to lender like with a traditional mortgage -- but instead, the lender makes payments to the borrower each month. The payments are based on a portion of the home’s equity that the borrower has accumulated.
There are plenty of reverse mortgage loans on the market from various sources. However, the most popular reverse mortgage loan package just happens to also be the only one that is guaranteed by the U.S. government.
Home Equity Conversion Mortgage Basics: How the HECM Works
Home Equity Conversion Mortgages are the only reverse mortgage product that is insured by the United States government. Like most reverse mortgage loans, a HECM is an amazing way for homeowners over the age of 62 to earn some extra income without relying solely on social security or pension funds.
With the home equity conversion mortgage, many of the common reverse mortgage rules still apply. For instance:
Borrowers must live in the home as a primary residence in order to even qualify, and must remain living in the home.
The loan is only due to be repaid if the borrowers move from the home, sell the home, or pass away.
HECM: How Do I Get My Money?
The loan proceeds can be paid out to the borrower in a few different ways. These include a monthly payment, a lump sum, or even a line of credit. Since the FHA guarantees the loan, borrowers can also expect to be responsible for paying mortgage insurance premiums.
The money received through a home equity conversion mortgage, much like any other reverse mortgage, is free for the borrower to use as they see fit, with no restrictions. A HECM can even be used to purchase a primary residence on the condition that the borrower is able to pay cash for the difference between the HECM loan proceeds and the sales price, plus closing costs for the home being purchased. While borrowers are not required to make payments toward their principal while a reverse mortgage is in effect, they must still maintain the property and pay any other homeowner fees that they are responsible for. This might include property tax or homeowners insurance.
Types of Home Equity Conversion Mortgages
A little-known fact about HUD’s reverse mortgage program is that there isn’t only one type of HECM loan. The home equity conversion mortgage loan program is actually split into three separate HECM loans, that are based on how the HECM is to be used.
The traditional home equity conversion mortgage is the basic package, and it’s similar to other reverse mortgage loans on the market. HUD’s traditional HECM comes with either a fixed interest rate or an adjustable interest rate. The value of the payout is determined by the borrower’s age, and the value of the equity in the property. Proceeds can be used in any way the borrower chooses.
HECM for Purchase
The HECM for purchase program exists for those eligible for a reverse mortgage who would like to use the proceeds to purchase another home. Rather than enduring two separate mortgage transactions, the HECM for Purchase program enables borrowers to complete both their reverse mortgage and their home purchase with one single transaction where any fees and closing costs are rolled into one.
HECM for Refinance
For borrowers who already have a reverse mortgage, the HECM for refinance was created to allow borrowers a chance at refinancing their current loan. People tend to refinance reverse mortgages in order to get better interest rates, incorporate their spouse into their mortgage documentation, or to try to receive more money by increasing the valuation of the mortgage loan.
How to Qualify for a Home Equity Conversion Mortgage
Qualifying for any reverse mortgage takes a few things. First, you must be at least 62 years of age at the time you apply for the loan. Next up, you must be using the property as a primary residence.
Note that living in the home is a condition of all reverse mortgages. You will need to repay the loan should you stop living in the residence for any reason, even if that means passing away. On top of that, reverse mortgages pay out money to borrowers based on the amount of equity that the property has accumulated. So it is a bit of an unspoken requirement that you must also have a substantial amount of equity in your home in order to get a reverse mortgage.
Since HECMs are guaranteed by the Federal Housing Administration, you can also be sure that there are a few extra requirements involved.
HECM Borrower Requirements
In order to qualify for a HECM, a borrower must meet the following criteria:
Must be at least 62 years old
Must own the property outright or have considerable accumulated equity
Must live in the property as a primary residence
Must be able to continue paying for property taxes, homeowners insurance, and any other fees associated with homeownership
Must be up to date with any federal debt obligations (no delinquencies)
Must attend mandatory HECM counseling session by HUD-approved HECM counselor
HECM Borrower Financial Requirements:
If you are able to meet all of the requirements above, the next thing that will be scrutinized is your financial profile. Lenders will need to verify:
Credit report, income, assets, and monthly living expenses
Whether or not you have been and are able to make payments of hazard insurance, real estate taxes, and flood insurance premiums on time.
HECM Property Requirements
The eligibility requirements for a home equity conversion mortgage aren’t limited to borrowers either. To qualify, the property must also meet the HUD’s eligibility criteria. A potential HECM property must meet all FHA safety and health standards as well as flood requirements. Acceptable property types include:
A single family property, or a 2-4 unit home in which one unit is occupied by the potential borrower
HUD approved condos
FHA standard manufactured homes
How a Borrower Receives Home Equity Conversion Mortgage Payments
While you might’ve heard that recipients of reverse mortgage payments receive payments on a monthly basis, there are actually a few different payment options that borrowers can choose from. The payment options are based on whether or not the borrower’s mortgage
loan package has an adjustable interest rate or a fixed interest rate.
HECM Payment Options Based on an Adjustable Interest Rate
Based on an adjustable rate of interest, there are quite a few different payment options available to borrowers. These include:
Term: Payments are made in equal monthly installments for an agreed upon number of months.
Tenure: Payments are made in equal installments for as long as the borrower lives in the home as a primary residence
Line of Credit: Payments can be requested in an unscheduled manner, and in amounts of the borrower’s choosing, until the line of credit runs out
Modified Term: A combination of term and line of credit payments, where the borrower can draw money as they need it, but monthly installments are still being made for a set amount of months, or until the line of credit runs out.
Modified Tenure: A combination of tenure and line of credit payments, where the borrower can draw money as they need it, but monthly payments are still made as long as the borrower occupies the house.
HECM Payment Options Based on a Fixed Interest Rate
For a fixed interest rate, you don’t get as much choice when it comes to receiving payments. Borrowers with a fixed interest rate are automatically given the Single Disbursement Lump Sum payment plan.
How Much Money Can You Get from a HECM?
The amount of money that a borrower is eligible to receive from a home equity conversion mortgage is based on a few key factors. According to HUD, the payout amount takes into consideration:
The age of the YOUNGEST borrower, or non-borrowing spouse (if eligible)
The type and value of the borrower’s current interest rate
The lesser of:
The FHA appraised home’s value
The national HECM FHA mortgage limit of $679,650
If the HECM is to be used for a purchase, then the sale price of the home
Can a HECM Be Refinanced?
Every HECM program is different, but the short answer is yes, they absolutely can be refinanced. A HECM can actually be refinanced to pay off an existing HECM loan. This is sometimes known as a HECM to HECM or “H2H” Refinance. This type of refinancing is a great way to increase cash flow. However, the opportunity to pull off a smart H2H refi only presents itself under certain circumstances. For Example, one should consider an HECM to HECM Refinance if:
The Home’s Value has increased (substantially) since the original HECM was originated
More favorable interest rates are available
The original reverse loan has a payout cap that is lower than the current limit
There is a need to switch from an adjustable-rate to a fixed-rate loan, or vice versa
The spouse of the borrower has reached the age of eligibility (62) and would like to be added to the documentation (for protection on the title)
Even if a borrower does decide to refinance, they must still pass one more hurdle. Lenders will not bother refinancing a HECM unless the additional cash that they will receive is at least five times the value of the closing costs.
On a lighter note, when a HECM is refinanced, the initial mortgage insurance premium is credited toward the new mortgage insurance premium amount. The added value there makes closing a HECM refinance transaction less costly.
What Are the Costs of a Home Equity Conversion Mortgage?
Reverse mortgages (HECMs included), much like almost everything else in today’s society, aren’t free. As a matter of fact, the costs of a reverse mortgage transaction are usually enough to turn most people away.
The beautiful thing about a HECM is that unlike some other reverse mortgage packages, most of the fees can be financed right into the loan. Of course, this reduces the amount of money that a borrower is eligible to receive, but at least it removes the burdens of heavy upfront closing costs. Besides the standard loan closing costs, typical HECM fees include (but are not limited to):
Mortgage Insurance Premiums (MIP): The payment of mortgage Insurance premiums is standard with all loans guaranteed by the FHA. Both an Upfront MIP payment of 2% of the loan value and recurring Annual MIP payments of 0.5% of the remaining mortgage balance are required of HECM borrowers.
Origination Fee: This represents the cost for the lender to process the borrower’s application. Lenders may charge based on the greater value between $2,500 or 2% of the first $200,000 of the home's value, plus 1% of the remaining amount over $200,000 when applicable. However, origination fees have a set cap, and cannot surpass $6,000
Servicing Fees: A monthly fee of up to $35 to compensate the lender for servicing the loan throughout the entirety of its term
Reverse mortgage counseling: A mandatory counseling service must be completed in order to be approved for any reverse mortgage. Fees vary, but are almost always expected to be paid by the borrower.
The Home Equity Conversion Mortgage: In Review
Reverse mortgages can be pretty confusing. Even if you do qualify for one, there are tons of costs and fees and red tape to get through. On top of that, many of the reverse mortgages you find out in the wild are more like scams than anything else.
That’s why the HUD’s take on the typical reverse mortgage is a breath of fresh air. In creating the HECM program, the FHA has provided a trustworthy source for a set of awesome reverse mortgage loan packages that are practically tailored for a borrower’s needs. Okay, so you probably won’t be able to avoid the fees, or the red tape for that matter, but at least you can rest easy that you’re getting a reliable reverse mortgage with a pretty decent interest rate. And you can eve refinance when the opportunity arrives. Peace of mind after retirement never looked so good.