Home Equity Conversion Mortgage (HECM): Everything Seniors Should Know
February 06, 2024 6-Minute Read
Author: Hanna Kielar
For 50 years, reverse mortgages have helped seniors reach their financial goals in retirement. In 1961, the very first reverse mortgage helped Nellie Young keep her home after her husband passed away. Since its creation, the reverse mortgage has gone through several transformations, with its uses expanding to help seniors supplement their retirement income, consolidate their debts, pay for emergencies or even purchase a new home.
While there are a few different types of reverse mortgages, the most common one is the Home Equity Conversion Mortgage (HECM), which provides various protections for homeowners and offers the most flexible way to receive and use their funds. However, while the HECM has helped many homeowners and has guidelines to protect borrowers, this financial option isn’t always the best one.
Although Rocket Mortgage® doesn’t offer HECMs at this time, we’re making this information available so you can understand how they work as well as the pros and cons.
What Is A Home Equity Conversion Mortgage And How Does It Work?
The HECM is a reverse mortgage loan insured by the Federal Housing Administration (FHA) for borrowers at least 62 years old. This government-insured loan allows homeowners to convert their home equity into cash. At this time, Rocket Mortgage® does not offer HECMs.
The HECM loan first pays off the existing mortgage, if there is one, then the rest of the money can be used for anything and there are no longer monthly mortgage payments required. However, homeowners are still responsible for paying their property taxes, homeowners insurance, and must continue to maintain the home. If the borrower decides not to make a monthly loan payment, interest for that month is added to the loan balance.
Monthly loan payments are optional, but a borrower can opt to make monthly payments since there are no prepayment penalties on HECMs. Monthly payments go toward the interest first, and then toward the fees and principal.
The HECM loan must be paid off entirely when the borrower moves out of the home, sells the home or passes away. Heirs can sell the home or purchase the home for the amount due or 95% of the appraised value – whichever is less. They can also choose to sign the deed over to the lender and walk away from the home.
How Is A HECM Different From Other Reverse Mortgages?
There are three kinds of reverse mortgages:
Of the three, the HECM is the only government-insured reverse mortgage and is the least risky because of various government protections for borrowers. We’ll discuss the protections later on in the article.
The HECM is what’s known as a nonrecourse loan, which means that a borrower will never owe more than their home is worth. If their home sells for less than what is owed on the loan, FHA insurance covers the difference – not the borrower or their heirs. There’s also no credit impact for the borrower or their heirs if they choose to give the house back to the lender.
How Is A HECM Different From A Home Equity Loan?
A home equity loan also issues cash based on equity but requires monthly payments shortly after the funds are received. With a reverse mortgage, monthly payments on the loan are optional unless certain requirements aren’t met (for example, property taxes and insurance aren’t paid, the home isn’t maintained, the house is sold, the borrower moved out or passed away).
Another difference between a HECM and home equity loan is that a HECM offers more ways to receive your proceeds. While a home equity loan only disburses your funds in one lump sum payment, a HECM offers a lump sum payment, monthly payments or a line of credit.
Eligibility requirements are different, too.
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How Do You Get A HECM?
A HECM is only available through a U.S. Department of Housing (HUD)-approved lender.
For the HECM process, there are a few unique steps you’ll take to apply for this type of loan.
Required HECM Counseling
Because of the complex nature of the reverse mortgage, HUD requires all borrowers to complete a reverse mortgage counseling session. The HUD-approved, third-party counseling session ensures you understand how the loan works, the costs associated with it and any other finance options you may have. Counseling may cost up to $200, lasts up to 90 minutes and may be done in person or, in some states, over the phone.
There are three factors that determine how much you can borrow with a HECM:
- The age of the youngest borrower
- Current interest rates
- The amount of equity you have in your home
To ensure borrowers are in a good financial position to take on the financial obligations of the loan (paying property taxes, homeowners insurance and home maintenance costs), HUD also requires the borrower to undergo a financial assessment during the process. During the financial assessment, the lender will review a borrower’s income, debts and credit history, though credit score is not a determining factor in getting a reverse mortgage. Depending on what the financial assessment reveals, the lender may decide to set some of the reverse mortgage proceeds aside to help pay for property taxes and insurance.
There are two types of HECMs: a fixed-rate HECM and an adjustable-rate HECM. The fixed-rate option has an interest rate that stays the same throughout the life of the loan and offers only one way to receive payment – in a lump sum. The adjustable-rate option has an interest rate that may fluctuate throughout the life of the loan and offers multiple payment options – a lump sum, monthly payments, a line of credit or any combination of the three.
If you choose this payment option, all of your reverse mortgage proceeds will be delivered in one lump sum payment. This option is available with both a fixed-rate or adjustable-rate HECM loan.
With this payment option, you’ll receive your proceeds in monthly payments. You can receive the monthly payments for a set amount of time, known as term payments, or you can choose to receive monthly payments throughout the life of your loan, known as tenure payments. This option is only available for the adjustable-rate HECM.
A reverse mortgage line of credit is a payment option that puts your proceeds into a line of credit that you can access whenever you need, similar to a home equity line of credit (HELOC). If you don’t use the money right away, the available funds in your line of credit can continue to grow in value over time, providing more money in the future.
As long as you have the loan, the line of credit cannot be suspended or called due. The line of credit payment option is only available with an adjustable-rate HECM.
For an even more customized payment option, you can also combine different payment options. For example, you can have your proceeds put into a line of credit and receive them as monthly payments at the same time. A combination of payments is only available with an adjustable-rate HECM.
What Are The Eligibility Requirements For A HECM?
To obtain a HECM, you’ll also have to meet the following criteria:
- You must be 62 years of age or older.
- The property must be your primary residence.
- You must have enough equity in your home.
- You can own your home free and clear or have an existing mortgage.
If you’re interested in getting a HECM, you’ll need to use an FHA-approved lender that offers this type of reverse mortgage. While Rocket Mortgage is an FHA-approved lender, we do not currently offer HECMs.
What Are The Pros And Cons Of A HECM?
It’s important to remember that reverse mortgages are complex loans and careful consideration is required before applying. Understanding the HECM’s benefits, as well as its drawbacks, will help.HECM ProsIn the right situation, a reverse mortgage can be a great addition to your retirement plan for several reasons. Here’s how you can benefit:
- You can use your reverse mortgage proceeds for anything you want, including consolidating your debts, supplementing your income or making home improvements.
- You can eliminate your monthly mortgage payments. Just remember to continue to pay your property taxes and homeowners insurance.
- You remain the owner of the home. Your name stays on the title.
- Credit score is not a factor when considering eligibility for a HECM.
- Since the HECM is insured by the FHA, borrowers are better protected from declining home values.
HECM ConsWhile reverse mortgages can be a helpful financial tool in retirement, they aren’t the best option for everyone. Here’s why:
- HECM loans typically have higher fees than traditional mortgages.
- Life is unpredictable. If a medical emergency or other incident keeps you out of the home for the majority of the year, your loan could come due.
- While your heirs do have options, the burden of dealing with the loan falls on them if you pass away.
- If you choose a payment plan that doesn’t last the life of the loan, you could outlive your proceeds.
The Bottom Line: A HECM Can Be A Great Option
A HECM is a loan that allows seniors to use the equity in their home while paying off their existing mortgage. Insured by the government, a HECM can be used to supplement your retirement income, but the mortgage can be complex and isn’t always the right option for everyone.
If you’re considering a HECM or other type of reverse mortgage, it’s important to look into alternative options as well, including a home equity loan. To discuss other home financing options, contact a Home Loan Expert. You can give us a call at (833) 326-6018.
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