A home equity conversion mortgage is the most common type of reverse mortgage, and lets older homeowners turn their equity into cash and continue to live at home in their later years.
HECMs are an appealing solution to the dilemma of being “house rich and cash poor.” But they also are complicated financial products, and it’s important for homeowners to fully understand the pros and cons of an HECM before committing to one.
Here’s what you need to know about HECMs:
- What Is an HECM and How Does It Work?
- Who Can Get an HECM?
- How Do You Get an HECM?
- How and When Do You Repay an HECM?
- HECMs vs. Other Reverse Mortgages
- HECMs vs. HELOCs, Home Equity Loans, and Cash-Out Refinancing
- Pros and Cons of an HECM
- Home Equity Conversion Mortgage FAQ
- The Bottom Line on HECMs
What Is an HECM and How Does It Work?
A home equity conversion mortgage lets homeowners ages 62 and older borrow cash against their equity while they continue to live in their home. The loan is paid to the homeowner as regular payments, a lump sum, or a line of credit.
The borrowed money is added to the mortgage balance, reducing the homeowner’s equity. This is why it’s called a reverse mortgage — instead of the owner paying the lender to reduce the principal, the lender pays the owner and adds to the principal.
An HECM doesn’t have to be repaid as long as the owner is living in the home. When the owner moves out, sells the home, or dies, the loan then must be repaid in full. Often, the home is sold, with the proceeds used to repay the HECM. Any remainder would be paid to the seller, their family, or their estate.
How much money can I get?
How much cash you can get from an HECM depends on a few factors.
One is your equity, which is the difference between the value of your home and how much you still owe on it. More equity means you can borrow more money.
Another is the homeowner’s age. The older you are, the more equity you can borrow. The percentage of a home’s equity that a borrower can access increases through age 90.
HECMs also have a maximum loan amount set by the Federal Housing Administration, which insures HECM loans. In 2022, the FHA set the maximum loan amount it will insure at $970,800.
In general, lenders will let you borrow a percentage of your equity — usually no more than 75% — so you can expect the maximum loan you receive to be a percentage of your full equity amount, up to the FHA limit.
If you still owe money on a traditional mortgage, you must use your HECM to pay off that loan.
What costs do I need to pay?
A home equity conversion mortgage is a loan, which means there are costs associated with borrowing the money. Some of these fees are paid upfront, while others are ongoing charges:
- Mortgage insurance premiums. You’ll pay an FHA-required upfront fee of 2% of the loan’s value, plus an annual fee of 0.5% of the outstanding balance.
- Reverse mortgage counseling fee. Before you can apply for an HECM, you must complete a session with a government-approved counselor. The counseling fee may vary, but typically costs $125 to $200. Low-income older homeowners may qualify to delay paying this fee until their reverse mortgage closes.
- Origination fee. This fee compensates the lender for setting up the loan. It’s $2,000 plus 1% of your home’s value over $200,000, with a minimum charge of $2,500 and a maximum of $6,000.
- Third-party fees. Just like taking out a mortgage, getting an HECM requires things like appraisals, inspections, and insurance. These fees are paid as part of your loan’s closing costs.
- Servicing fees. Lenders can charge ongoing costs to continue servicing the loan. These fees are capped at $35 per month.
What can I use the money for?
There are no restrictions on how borrowers can use HECM funds. Many people use them to supplement their retirement income; to pay for essential expenses and bills; to cover medical care; or to consolidate other debts.
How is the loan distributed?
Borrowers can choose to receive HECM funds in a few different ways:
- Tenure. Under this plan, borrowers receive equal monthly payments as long as they live in the home.
- Term. Borrowers receive equal monthly payments for a fixed period of time.
- Line of credit. Borrowers can access their home equity as they need it, without set payment amounts or due dates.
Borrowers also can choose a mixture of term or tenure with a line of credit, and receive regular payments while having the flexibility to make larger withdrawals as needed.
Who Can Get an HECM?
HECM loans are designed for older homeowners who want to turn their home equity into a source of income. There are a few requirements to meet.
The youngest borrower on the loan must be at least 62 years old. You also need to occupy the home securing the loan as your primary residence, have a minimum of about 50% equity in the home, and not be delinquent on any federal debts, including income taxes and student loans.
Additionally, you must show that you have sufficient financial resources to keep the home in good condition, and to continue paying property taxes and homeowners insurance.
You can only apply for an HECM on a single-family home or a home with two to four units. You must occupy the home or one of the home’s units as your primary residence. You also can qualify with a condominium approved by the U.S. Department of Housing and Urban Development or a manufactured home that meets FHA requirements.
You need sufficient equity in your home. That can mean owning it outright, having paid off a significant portion of your mortgage, or experiencing a significant increase in your home’s value since getting your mortgage. Typically, the minimum equity required is around 50%.
How Do You Get an HECM?
One of the first steps to getting an HECM is reverse mortgage counseling. Your counselor will walk you through how HECMs work, their pros and cons, and alternatives that might be available to you.
After counseling, if you think a reverse mortgage is the right choice for your situation, you can start looking for lenders. Try to work with a reputable company, and take the time to shop around. Compare offers from multiple lenders to find the best deal for you.
Beware of scams and fraud
One of the unfortunate truths about home equity conversion mortgages is that potential borrowers are a popular target for scams and fraud. These are ways to avoid HECM scams:
- Don’t respond to unsolicited advertisements.
- Be sure to consult a lawyer before signing any paperwork you don’t fully understand.
- Don’t let your lender disburse loan funds to anyone but you.
- Don’t buy any financial products or hire an expensive service to help you get an HECM.
How and When Do You Repay an HECM?
You generally don’t have to repay an HECM until the home is no longer your primary residence. This can happen because you move out, sell the home, die, or spend more than a year in a health care facility.
You also may have to repay your HECM if you fail to pay property taxes or to keep the home in good repair.
If your spouse is a co-borrower on your loan, they can remain in the home even after you die. However, they will be ineligible to receive additional payments from the lender. Spouses who are not co-borrowers can remain in the home after their partner dies, if they meet HUD requirements.
To be eligible, you must have been married when you closed on the HECM or in a marriage-like relationship at the time, and the spouse must have lived in the home at closing and when their partner died.
Typically, the homeowner or their estate pays back an HECM loan by selling the home. The lender will use the proceeds from the sale to repay the HECM balance, with any remaining cash going to the seller or their estate.
If the owner’s heirs or the estate want to keep the home, they can pay off the HECM in full, or refinance to a traditional mortgage.
If the home sells for less than the balance of the HECM, the owner won’t have to pay the difference out of pocket. The lender will take the full amount of the sale, and mortgage insurance will cover the rest.
HECMs vs. Other Reverse Mortgages
HECMs are one type of reverse mortgage. There also are proprietary reverse mortgages and single-purpose reverse mortgages, which have their own pros and cons.
Single-purpose loans often come from nonprofits or local governments, rather than private lenders. This means there can be additional restrictions compared to HECMs.
Proprietary reverse mortgages, by contrast, have fewer restrictions and come directly from lenders with no government insurance.
HECM vs. Proprietary and Single-Purpose Reverse Mortgages
|HECM||Proprietary reverse mortgage||Single-purpose reverse mortgage|
|Minimum borrower age||62||Varies||Varies|
|Reverse mortgage counseling required||Yes||No||Varies|
|Restrictions on use of funds||No||Varies||Varies|
|Mortgage insurance required||Yes||No||Varies|
HECMs vs. HELOCs, Home Equity Loans, and Cash-Out Refinancing
Instead of using an HECM, you might choose another type of home loan to turn your equity into a source of cash. Home equity lines of credit, home equity loans, and cash-out refinancing are a few alternative options.
HECMs vs. HELOCs, Home Equity Loans, and Cash-Out Refinancing
|HECM||HELOC||Home equity loan||Cash-out refinance|
|Minimum borrower age||62||None||None||None|
|Restrictions on use of funds||None||None||None||None|
|Reverse mortgage counseling required||Yes||No||No||No|
|Availability of funds||Lifetime||Limited term||Lump sum||Lump sum|
|Limited closing costs||Yes||No||No||No|
|Monthly payments required||No||Yes||Yes||Yes|
Pros and Cons of an HECM
Home equity conversion mortgages can help older homeowners turn their equity into a source of income, and allow them to continue living in their homes.
“A reverse mortgage can be an ideal solution for many older homeowners who want to remain in their home as long as possible,” says J.D. Dinnocenzo, vice president of reverse mortgage lending at Family First Funding in Delray Beach, Florida. “Since home equity is typically one of the largest assets that people have when they retire, incorporating a portion of home equity into a comprehensive retirement plan can sometimes be a wise financial decision.”
But HECMs aren’t right for every older homeowner, says Corey Tyner, president of Buy Yo Dirt, a Phoenix-based real estate investment firm.
“The borrower is responsible for keeping the house in good repair and paying property taxes and homeowners insurance,” he says. That could leave you using the proceeds of your loan just to keep it open.
Tyner also says that closing costs can be expensive and reduce the amount of cash you have available. It’s important to pay close attention to the terms of your HECM to make sure that the loan provides sufficient funds for your needs.
Home Equity Conversion Mortgage FAQ
These are some common questions people have about HECMs.
The good news is that the amount you borrow with an HECM is considered a loan, and therefore is not taxable income. However, unlike the interest paid on a traditional mortgage, you cannot deduct the interest paid on an HECM from your taxable income.
When you die or move out of your home, a qualifying spouse may remain in the home. However, once they move out or die, your HECM will come due. If the loan isn’t repaid immediately, the lender has six months to begin foreclosure proceedings. A delay of foreclosure can be requested for up to 180 days.
If you run out of equity in your home, you can’t use the line of credit on your home to continue withdrawing funds. However, you’ll still receive payments for the tenure or term portion of the HECM.
The Bottom Line on HECMs
Home equity conversion mortgages are complex financial agreements that let you use your home as a source of income in retirement. While they can be appealing to older homeowners, make sure you truly understand how they work before you commit to an HECM.