You bring in the down payment, the bank finances the rest with zero mortgage payment. Sound crazy? Hang with me and I’ll explain!
Normally, the only way to purchase a home with no mortgage payment is to pay cash for the house. No mortgage balance means no mortgage payment, right?
Well, the downside to paying cash is that you lock up a lot of money in the home. Home equity is great to have, but you can’t use it for anything. You can’t exchange it for plane tickets to visit your grandchildren, right?
Home equity is essentially money locked away and unavailable to fund your retirement lifestyle.
The beauty of the HECM for purchase program is this: you can avoid the mortgage payment without having to come up with 100% cash to buy the home outright. This keeps money in your pocket instead of locking it away in the home where it can’t be used. This enables you to keep more money on hand to fund your lifestyle or cover emergency expenses. It also keeps you from having to add yet another payment to the monthly budget.
HECM for purchase basics
The HECM, or home equity conversion mortgage (often pronounced heck-um) is a federally-insured mortgage program that enables homeowners 62 and over to use the equity in their homes to enhance their financial well being in retirement.
Most HECMs are “refinances”, meaning the homeowner taps into equity in a home they already own and live in. HECM refinances are commonly used to get rid of existing mortgage payments, pay off other debts, finance home improvements, or supplement income or retirement assets.
HECM for purchase also enables you to tap into equity, but in a more indirect manner. Instead of cashing out equity in a home you already own (as with the refinance HECM), the purchase HECM keeps cash in your pocket. Instead of putting down 100% cash to avoid a mortgage payment, you can instead put down a portion of the purchase price and the lender will finance the rest without a mortgage payment.
The following are some notable features of the HECM:
- No monthly payments are required and the loan does not have to be repaid as long as at least one borrower is living in the home.
- You remain the owner of the home and are free to will it to your heirs.
- The HECM has no impact on income taxes, Social Security, or Medicare benefits.
- The HECM is non-recourse. You, your estate, and your heirs are protected if the home isn’t worth enough to settle the entire loan balance. FHA will settle any shortage.
Your obligation is to pay required property charges (property taxes, homeowners insurance, HOA dues, etc.) and live in and maintain the home as your primary residence. As long as at least one borrower is doing that, no payments are required.
Because the HECM is a mortgage, it accrues interest on an annual basis. Interest rates are usually comparable to prevailing rates for traditional home loans. If you choose not to make a monthly payment (which is the point, right?), the interest simply accrues onto the loan balance over time.
How your down payment is calculated
The total amount of money the lender will finance is called the principal limit, or PL. Think of this as the total bucket of cash that FHA allows under the HECM for purchase guidelines. The PL is calculated based on the following factors:
- Home value or purchase price (whichever is lower)
- Current interest rates
- Age of the youngest borrower or non-borrowing spouse
- The HECM program you select (whether fixed-rate or variable-rate)
Because interest rates change and home values, ages, etc. vary from one borrower to the next, no two HECMs are exactly the same. There is no set amount or percentage of the home’s value that every borrower qualifies for. Your down payment is simply the difference between the principal limit and the lesser of the purchase price or home value, plus closing costs.
Because the HECM is open-ended with no set payoff date, age plays an important role in determining how much you qualify for. Older borrowers tend to qualify for more money and younger borrowers tend to qualify for less.
Interest rates also play an important role. When interest rates decrease, principal limits increase. As rates increase, principal limits decrease. Depending on interest rates, most borrowers tend to qualify for 40% to 60% of the home value.
Let’s take a look at an example to see how this works. Let’s assume a borrower named John is purchasing a home for $200,000. For simplicity, let’s also assume the home appraises for the same amount as the purchase price (note that real life doesn’t always work this way).
Based on his age, current interest rates, and the program he selects, John qualifies for a PL of 45% of the value of the home, or $90,000. This is the amount the lender will finance.
John’s down payment is the difference between the PL and purchase price, plus closing costs. If the purchase price is $200,000 and the bank finances $90,000, the down payment will be $110,000. Assuming closing costs are an additional $10,000, John will need a grand total of $120,000 to close the deal.
What this all means
Let’s think about what all this means for a minute. If a HECM enables you to finance roughly half the purchase price of a home without a mortgage payment, then you can keep tens or hundreds of thousands of dollars in the bank instead of locking them away in unusable home equity. You don’t need to come up with 100% cash to avoid the mortgage payment. The HECM enables you to keep more cash in the bank to fund your retirement lifestyle and cover unexpected expenses like medical bills or home repairs.
The HECM also enables you to effectively double your purchasing power. In a “normal” world, if you have $100,000 to buy a house and you don’t want a mortgage payment, you’re limited to buying homes priced at $100,000 or less.
But if you can finance half the purchase price with no mortgage payment, you can now spend up to $200,000 for a home and still have no mortgage payment. The HECM for purchase program can significantly increase your purchasing power.
Real estate agents, are you paying attention? 🙂
For some inexplicable reason, FHA used to disallow seller concessions of any kind. With the publishing of the “Final Rule” in late 2017, FHA loosened up a bit and now allows for limited seller concessions considered “usual and customary” for the area.
For more specifics for your area, be sure to check with a reputable HECM lender and/or realtor familiar with the HECM program.