Home Equity Conversion Mortgage (HECM)
TABLE OF CONTENTS
Home Equity Conversion Mortgage (HECM) is the long, bureaucratic name for a Federal Housing Administration’s (FHA) reverse mortgage program. If you prefer brevity, you’ll be pleased to know that most folks just call it HECM.
The HECM program is for homeowners 62 years old and older. Home equity is converted into cash disbursed to the borrower. It’s a loan, not a freebie. So it has typical mortgage features that you might expect. The home is the collateral for the loan. Naturally, there’s an interest component. It accrues during the life of the loan. And, yes, the loan eventually must be paid back.
The reason reverse mortgages have grown in popularity over the years is that they help seniors stay in their home without needing to make a monthly mortgage payment. While there are some proprietary (private) reverse mortgage products on the market, roughly 90% of reverse mortgages taken out are federally-insured HECMs.
What Role Does the Government Play?
The US Department of Housing and Development (HUD) regulates and insures HECMs through its subsidiary, the Federal Housing Administration (FHA). You will see HUD and FHA used interchangeably in this article. HUD and its subsidiary FHA play an important role in the reverse mortgage market. They help increase the adoption and availability of reverse mortgages by insuring lenders and creating guidelines that protect consumers.
The first thing to know is that the government is not the lender. Instead, FHA insures the loans that private institutions — like mortgage companies and credit unions — make. This backing, or insurance, reduces some of the lender’s risk when they issue loans. With a potion of the risk absorbed by FHA, lenders are predisposed make more loans; it keeps the mortgage market moving.
Second, HUD writes the guidelines that lenders most follow in order to have their mortgages insured by the FHA. So HUD plays a role in defining the HECM program and safeguarding the borrower.
Just so you know, no taxpayer money is used to insure mortgages. In fact, mortgage insurance is paid by borrowers in the form of a one-time premium at the loan’s closing as well as periodic insurance payments over the life of the loan.
HOW HECM LOANS HELP SENIORS
Reverse mortgages help homeowners increase their quality of life by borrowing against the stored up equity in their home. Seniors don’t have to sell their home or move out to do that. And they don’t have to make monthly mortgage payments. For those reasons, HECMs are an attractive financial vehicle for many. Some common reasons to take out a reverse mortgage include:
- Supplement retirement income
- Repair, upgrade or adapt homes for senior living
- Purchase another home
- Prepare for unexpected expenses
- Pay for medical expenses
- Eliminate existing debt
The following requirements and guidelines help create a safe and stable HECM program. Requirements change from time to time as more data about reverse mortgages are collected and analyzed. The aim is to continually improve the HECM program. The three eligibility pieces have to do with the borrower, the property and occupancy of the property.
- 62 years old or older, but not everyone who lives in the home needs to be a senior
- Cannot be delinquent on any federal debt
- No income restrictions
- Prior to obtaining a loan, borrowers must first meet with a HECM counselor
- Have the financial capacity to meet ongoing financial obligations such as property taxes and homeowner’s insurance
- The existing mortgage is paid off (borrower holds title) or mostly paid off
- Single-family residence
- 2 to 4-unit home (duplexes, etc.) with one unit occupied by borrower
- HUD-approved condos
- Some manufactured housing
- Co-ops and mobile homes are not allowed
- Dwelling must be at least one year old
- Must meet HUD’s minimum property standards and flood requirements
Homes that are put up as loan collateral must be a primary residence and owner-occupied. So it won’t work for a rental property or a home you intend to rent out.
You must actually have to live in the home “most” of the year. Technically, the requirement is 183 days per year or more. So snowbirds — people who live in northern climates summer and southern climates in winter — will have to sort out how they will comply with the occupancy requirement. It might mean paying closer attention to the amount of time you spend between Seattle and Arizona or between New York and Florida.
After the loan closing, Loan Servicers manage the ongoing management of the mortgage (payments, monitoring, etc.) HUD requires loan servicers to keep track of property occupancy with an annual Occupancy Certificate that is mailed to borrowers. Borrowers must sign and attest to the fact that the property is their primary residence. If you think you can dodge the mailer, servicers even monitor returned mail! If you are not in your home for 12 months or more, your loan may default.
Borrowers may receive loan proceeds a number of ways. A particular disbursement might be advantageous depending upon your situation. Here are some payout options:
Line of Credit
Borrowers can withdraw money at any time and until the equity line is exhausted. The line of credit grows over time, meaning the amount of available funds will typically increase. That’s because each year the borrower is one year older plus the home may have appreciated – age and home value being a couple key factors in determining the loan limit.
Borrowers receive equal monthly payments for the life of the loan as long as the they remain eligible (alive, still living in the home). Payments continue eve if the loan balance exceeds the value of the home.
Modified Tenure/Line of Credit
This is a combination of a line of credit and equal monthly payments.
Borrowers receive equal monthly payments for a fixed number of months.
Modified Term/Line of Credit
This is a combination equal monthly payments and line of credit for a fixed number of months.
Loan proceeds are disbursed all at once. This loan must be a fixed rate mortgage. No additional draws may be made. They only way to extract more money from the home at a later date is to refinance the mortgage. That would be a costlier move as there would be additional closing costs for the refinance.
HECM LOAN FEATURES BY RATE TYPE
Reverse mortgages come in two familiar flavors, as a Fixed Rate Mortgage (FRM) or an Adjustable Rate Mortgage (ARM). Here’s the breakout of HECM payout options and other loan features available under each rate type.
PRINCIPAL LIMIT (LOAN LIMITS)
Each year, HUD revises (or leaves alone) the maximum loan amounts for FHA-insured reverse mortgages. Loan limits are reviewed in order to keep pace with regional real estate market prices. Loan amounts are also based on the age of the borrower. Current interest rates also play a role in determining how much equity can be withdrawn from the house.
Age of Borrower
The age of the borrower will party determine how much a borrower — as a percentage of the home’s value — can extract from their home. The calculation is actuarial in nature. That is to say, the older the borrower, the more equity can be taken out.
For example, a borrower who is 62 years old is expected to live longer than a borrower who is 80 years old. Therefore, the 80-year-old will be able to pull more equity out because they will — mathematically speaking — not live as long as a 62 year-old.
Age of Non-Borrowing Spouses
If one of the tenants is a non-borrowing spouse (a spouse not named on the loan), his or her age is used as the basis for how much equity can be extracted.
Before 2014, non-borrowing spouses did not have the same legal rights to the property. If the reverse mortgage was taken out in the name of only one spouse and he or she was no longer eligible (death or moved out) then the non-borrowing spouse would be forced to vacate the property, too. Currently, non-borrowing spouses are now protected.
However, this will change the loan limit. It will be calculated from the age of the youngest borrower or non-borrowing spouse.
- Dan is 69 years-old and his wife, Linda, is 65. Both of them will be named as borrowers. Linda’s age will be used to calculate the loan limit because she is the youngest borrower.
- Roy is 71 years-old and his wife, Julie, is 60. Julie is too young to be named as a borrower on a reverse mortgage. Thus, she is considered a non-borrowing spouse. Her age will be used to calculate the loan limit. Because she is younger than Roy, the total loan amount available will be lower. However, Linda will not have to move out of the home if one day Roy moves into an assisted living center or passes away.
Current Interest Rates
Just like any loan, today’s market rates dictate the “cost of money”.
Value of the Home
The more the home is worth, the more stored equity from which to draw. However, there is an upper limit. For all HECM programs, the loan limit is the appraised value, the sales price or the FHA mortgage limit of $625,500, whichever is less.
FHA limits vary from region to region. To define them, HUD looks at median home values by county and sometimes at a more “zoomed in” level like metro areas. Then they make adjustments as needed based on local market prices. Some areas have higher loan limits (cities) and some have lower limits (rural counties). So you might hear someone say, “The Clark County FHA limit is $417,000.” You can look up FHA Mortgage Limits for your county or city on HUD’s site.
Prior to 2015, the underwriting process for reverse mortgages was fairly minimal. Lenders didn’t worry too much about a borrower’s income or credit history. The feeling in the financial community was that income and credit didn’t matter since the loan came from home equity. Plus, reverse mortgages didn’t require borrowers to make monthly payments. So why worry about income? Turns out, a fuller picture of the borrower’s financial profile was required.
Today, the reverse mortgage underwriting process includes a Financial Assessment of the borrower’s credit and capacity to pay for ongoing Property Expenses like taxes, insurance and maintenance. There’s a new emphasis on planning for the long run. Here’s a look at the underwriting guidelines for HECMs.
Credit Report / Credit Score – Lenders will pull a three bureau credit report (called tri-merge) which will paint a picture the borrower’s payment history and outstanding debts. Chapter 7 or Chapter 13 bankruptcies do not automatically disqualify a borrower, but a recent track record of on-time and in-full payments will need to be demonstrated.
Capacity – Underwriters will perform an income analysis that looks at the borrower’s cash flow. They’ll want to determine if using an HECM is sustainable solution for them.
It’s important to make an accounting of all income such as employment, retirement assets (401k, IRA, etc.) rental income, pensions, alimony, VA benefits, Social Security, disability, workman’s comp or public assistance. Just so you know, it is illegal to discriminate against folks who receive income from public assistance.
Debts – Underwriters will look at unpaid federal or state taxes, ongoing property charges like local taxes and hazard insurance and utilities. The credit report will show how many outstanding credit cards a borrower has along with revolving account balances. They’ll want to know about court ordered alimony and/or child support.
Life Expectancy Set-Aside (LESA)
HUD wants to make sure borrowers will be able to pay for the ongoing costs of owning a home (e.g. property taxes and insurance). These ongoing costs, known as Property Charges, must be paid by the homeowner. The HECM Financial Assessment helps determine whether borrowers would be in better position to pay for property charges if some of the loan proceeds were held in reserve. The Life Expectancy Set-Aside or “LE Set-Aside” does just that.
- For reverse mortgages where a lump sum distribution is taken, LESA is a reserve to pay for property charges throughout the life of the loan.
- For mortgages where a monthly distribution is taken, the loan servicer withholds funds from the monthly distribution to pay the property charges.
- Alternatively, it’s possible to charge such funds to a line of credit.
- If there is more than one borrower, the portion of the age portion LESA calculation will be based on the youngest borrower.
Because the property is the collateral for the loan, it must meet FHA minimum property standards. The government doesn’t want to insure structures that are not durable. Sometimes home repairs are required in order obtain a reverse mortgage loan. A portion of proceeds from the HECM may be allocated into a Repair Set-Aside for such cases.
Initial Disbursement Limit
Borrowers can only access a portion of their available equity in the first year and subsequent years of the loan to prevent folks from blowing through the entire loan amount at once. This was once a problem but now there are “guardrails” on HECMs.
The FHA insurance program is paid for by borrowers in two ways.
Initial Mortgage Insurance Premium (IMIP)
This is the fee paid at closing. Borrowers pay one of two charges based on how much they borrow in the first year.
- 0.50% if borrowers take out 60% or less of the available Principal Limit in the first 12 months
- 2.50% if borrowers take out more than 60% of the available Principal Limit in the first 12 months
- One time charge at closing
Mortgage Insurance Premium (MIP)
Mortgage insurance continues for the life of the loan (until it is paid back). It doesn’t come out of the loan proceeds, it accrues over time until the loan is paid off.
- 1.25% of outstanding loan balance
- Annual charge, ongoing until loan is closed
REVERSE MORTGAGE COSTS
Reverse mortgages have similar closing costs as standard FHA programs. Many of these terms should look familiar.
Closing costs do not require and out-of-pocked payment. Fees can be rolled into the loan. You should know that those fees will accrue interest just like the loan principal. Here are some typical fees:
- HUD-approved counseling
- Credit report
- Loan Application
- Title search
- Lender origination fee
- Recording fee
- Initial Mortgage Insurance Premium (IMIP), a one-time fee, either 0.50% or 2.50% depending upon the percentage of equity withdrawn
As you know, reverse mortgages do not require borrowers to make monthly payments. Instead of monthly payments, ongoing loan-related expenses are added back into the loan amount. These expenses come due when the loan is eventually paid off. Here are some items that are rolled back into the loan:
- Mortgage Insurance Premium (MIP), annual recurring, 1.25% of outstanding loan balance
Taxes, Insurance and Maintenance
Borrowers have several ongoing responsibilities or Property Charges. Some borrowers will pay for them on their own, as they occur. For some borrowers, lenders may require setting-aside a portion of the initial loan proceeds to pay for Property Charges over time. In either case, borrowers are still responsible for things like:
- Property taxes
- Hazard insurance
- Flood insurance
- Homeowner’s association dues
OTHER REVERSE MORTGAGES
You can even buy a home with the HECM for Purchase program. For properties that exceed FHA County Limits, a proprietary (not government insured) Jumbo Reverse Mortgage could be your cup of tea. Here’s a quick look at both.
HECM for Purchase
Yes, you can actually buy a home and take out a reverse mortgage at the same time. Congress approved the HECM for Purchase program in 2008 to streamline and cut home buying costs for seniors. Before this program was enacted, some borrowers would buy a home with cash and then take out a reverse mortgage on the property. The HECM for Purchase program unifies these into a single transaction.
Reasons people consider the HECM for Purchase program:
- Downsize to a smaller house or one with less upkeep
- Move to a home that is adapted for senior living
- Relocate near loved ones
- Relocate to a state that doesn’t tax retirement income
- Relocate to an area warmer winters
Unlike a standard HECM, the HECM for Purchase requires a down payment. The lender puts up roughly half of the cost of the new home (47% to 52% of the purchase price). The Borrower has to come up with remainder (from savings, net proceeds from selling another house, retirement accounts or gift money).
Borrowers sell a home in Seattle, the proceeds of the sale are $400,000. They buy a home in Yuma, Arizona for $400,000. Instead of using all of the proceeds from selling their Seattle home, instead they put down $200,000 on the new Yuma home, taking out a reverse mortgage. Here is the result:
- They pocket approximately $200,000 ($400k sale proceeds minus $200k down payment = roughly $200k left over as borrowers covers the closing costs as well)
- They acquire a new home in Yuma and the new reverse mortgage covers the Principal and Interest
The borrower could have used the $400,000 Seattle home sale proceeds to buy the new house in Arizona. But in the scenario above, the borrower has roughly $200,000 to invest elsewhere, a new home and no mortgage payments.
Proprietary Jumbo Reverse Mortgage
For borrowers looking for a higher loan limit, some private lenders offer Jumbo Reverse Mortgages that cap loan amounts closer to the $2 million range. For seniors with bigger homes, this may be a more attractive option than selling other assets from their investment portfolio. Proceeds from reverse mortgages are tax-fee in most cases. Other investments may be subject to capital gains taxes.