What is a HECM loan? How does it work? Could a HECM be right (or wrong) for you? If you’re looking for answers to these questions, you’re in the right place.
Welcome to the ultimate online guide to the HECM! Once you’ve read this guide, you’ll likely know more about the HECM than many industry professionals. Written by an industry veteran, this is the only guide you’ll need to understand what a HECM is and how it works. Our goal is to provide objective and key information to help you decide if a HECM is worth pursuing further.
Note that this guide is not intended to be financial advice. We recommend consulting with the relevant qualified financial professionals before making a financial decision.
How to Use This Guide
This guide contains a wealth of information about a HECM. If you’re already familiar with the HECM, use the links in the Table of Contents below to jump to the information you’re most interested in.
You’ll also find links to more in-depth information on various topics scattered throughout this guide. The links open in a new browser window so you don’t lose your place on this page.
At the end of the guide, you’ll find links to our fantastic reverse mortgage calculators. Feel free to use the calculators to estimate how much HECM lenders may be able to offer you.
- What is a HECM?
- Why Congress Created the HECM
- HECM Features and Basics
- Rumors You May Have Heard (That Aren’t Actually True)
- Who Should and Shouldn’t Get a HECM
- How to Qualify for a HECM
- HECM Ongoing Costs
- HECM Closing Costs
- How Much Can I Get From a HECM?
- Finding Reverse Mortgage Lenders
- Reverse Mortgage Counseling
- How a Reverse Mortgage is Repaid
- Reverse Mortgage Calculators <— Click here for reverse mortgage calculator links
- Additional Resources
What is a HECM?
A HECM, or home equity conversion mortgage, is a reverse mortgage program that enables homeowners 62 and older to borrow against home equity without a mortgage payment.
Congress created the HECM (often pronounced heck-um by industry professionals) as part of the Housing and Community Development Act of 1987, which was signed into law by President Ronald Reagan. The Act gives the Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA) the authority to oversee, regulate, and insure the HECM.
The HECM is by far the most popular reverse mortgage in the United States. Other proprietary (or “jumbo”) reverse mortgage products exist, but they’re a small portion of the market and targeted at seniors with home values of at least $1 million. The material in this guide is relevant to the HECM specifically, but it can still be helpful if you’re seeking a jumbo reverse mortgage.
Why Congress Created the HECM
According to US Census data, the median household net worth for seniors 65 or older is $201,500. At first blush, that’s not a bad statistic. But here’s the problem: almost 70% of that number is locked up in the form of home equity.
Now, home equity is great to have, but it’s not liquid. If you don’t plan to sell your home (which is true for many seniors), it doesn’t matter whether you have a dollar or one million dollars in home equity. It’s just a number that has no practical impact on your life.
Case in point: there are seniors with million-dollar paid-off homes in the San Francisco area who practically live on cat food. They’re technically millionaires, yet they’re barely scraping by on a meager Social Security income.
Again, home equity is great to have, but it has no impact on your retirement lifestyle unless you can convert it into cash.
In the past, there were just two ways to convert home equity into cash: 1) sell the home, or 2) get a traditional “cash out” mortgage. The first option makes no sense if you want to continue living in your home. The second option, a “cash out” mortgage (including HELOCs), somewhat defeats the purpose of converting equity into cash. It doesn’t make sense to add yet another payment to the monthly budget if your goal is to free up cash.
Congress created the HECM to offer a third and better option.
HECM Features and Basics
If you’re at least 62 and a homeowner, the HECM enables you to convert home equity into cash. No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home, maintains it, and pays the required property charges.
The HECM becomes due and payable when the last borrower (or non-borrowing spouse) is no longer living in the home and paying the required property charges.
You always remain the owner of your home, which means you can leave it to your heirs. Your heirs can inherit any remaining equity in the home, whether they choose to keep the home or sell it.
The HECM is a non-recourse loan; FHA covers any shortage if you owe more than the home is worth at the time of repayment.
HECM proceeds have no impact on income taxes, Medicare, or Social Security retirement benefits. Proceeds can, however, impact Social Security disability benefits. If you receive such benefits, be sure to do your homework before getting a HECM.
The HECM is versatile and customizable, which means you can tailor it to your individual financial goals and needs. Proceeds are available as a lump sum, line of credit, monthly term/tenure income, or some combination of these options.
Seniors commonly use HECM proceeds to:
- Eliminate existing mortgage payments
- Eliminate other debts, such as credit cards, medical bills, and auto loans
- Finance home improvements
- Supplement retirement income
- Increase liquid retirement assets
- Set up a rainy day or emergency fund
There’s only one potential limitation on how you can use the money: FHA frowns upon using HECM proceeds to purchase annuities. Beyond that, you’re free to use the money for whatever you like.
Rumors You May Have Heard (But Aren’t Actually True)
Unfortunately, HECM rumors, myths, and misconceptions are rampant. Many seniors miss out on the benefits a HECM offers because of the rumors they’ve heard.
The following is a list of the most common myths and misconceptions you may have heard:
- “I’m giving up ownership of my home.” Not at all. A reverse mortgage is simply a home loan. You always retain title ownership of the home.
- “The reverse mortgage is only for broke and desperate people.” Not at all. Many so-called broke or desperate people often don’t even qualify. Many wealthy people take advantage of a reverse mortgage because it gives them additional cash management options they wouldn’t otherwise have.
- “The reverse mortgage will use up all of my equity.” Not necessarily. Yes, the HECM converts equity into cash, which means your loan balance rises over time. However, it’s also designed to preserve equity. Remember, the HECM is non-recourse. FHA covers the shortage if your home isn’t worth enough to pay off the entire balance. If a HECM reverse mortgage used up your equity quickly, FHA would be covering a lot of shortages and the HECM program wouldn’t be financially viable.
- “I’ll be leaving a big debt to my heirs.” Again, the reverse mortgage is non-recourse. You’ll never leave debt from the reverse mortgage to your heirs. You or your heirs are not responsible to cover the shortage if your home isn’t worth enough to pay off the entire balance.
- “Reverse mortgage interest rates are sky high.” Not at all. HECM interest rates are comparable to traditional mortgage rates.
- “The closing costs are expensive.” This is true sometimes, but not always. Regardless, the closing costs are not typically paid out of pocket. The exception is HECM for purchase, in which case the closing costs are paid as part of the down payment. We’ll cover more on closing costs and the HECM for purchase later.
- “The bank takes my house when I die.” Not at all. You are always the owner and you’re free to leave the home to whoever you wish. Your heirs can keep the home by paying off or refinancing the HECM balance. Or, they can sell the home, pay off the balance through closing, and keep the remaining equity.
- “I’m not allowed to take any long trips.” Not at all. Yes, you need to live in the home, but you can still take long trips and remain in good standing. You’ll meet the residency requirements as long as the home remains your primary residence and you live in it the majority of the year.
- “I can’t ever sell my house. I’m locked in for the rest of my life.” Not at all. The reverse mortgage is best for those who don’t plan to sell anytime soon, but you still have the option to sell if you need to. The process works just like it would for a traditional “forward” mortgage: you sell the home, pay off the reverse mortgage balance through closing, and the remaining equity goes to you. There is no prepayment penalty.
Who Should and Shouldn’t Get a HECM
The HECM reverse mortgage is a great financial solution, but it’s not always perfect for everybody. There are some scenarios where a HECM may not be the best option.
If you’re a homeowner and you owe less than half the value of your home, a HECM can help you:
- Get rid of existing mortgage payments.
- Pay off other debts, including credit card balances, auto loans, home improvement loans, and medical bills.
- Supplement retirement income.
- Supplement retirement assets.
- Set up a rainy day fund for financial emergencies.
- Pay for long-term care.
- Pay for home improvements and repairs.
- Preserve your existing retirement assets for longer.
A HECM may be a great option if one or more of the above would improve your financial situation. However, there are some scenarios where a HECM may not make not sense:
- You plan to move soon. There is no prepayment penalty or limitation on selling, but the reverse mortgage is best suited for those planning to stay in their homes. Much of the benefit comes over time. It usually doesn’t make sense to incur the closing costs if you’re not planning to keep the loan for long.
- You want to leave the maximum equity possible to your heirs. The HECM converts home equity into cash, which means your loan balance increases over time. A reverse mortgage may not be a good fit if your goal is to leave the most equity possible to your heirs.
- You live with children and/or disabled relatives and want them to remain in the home after you pass away. Remember, the reverse mortgage becomes due and payable in full when the last borrower or non-borrowing spouse no longer lives in the home and pays the required property charges. It may be best to avoid a reverse mortgage if you have children and/or disabled relatives living with you who won’t be able to settle the loan balance after you pass away.
- You know you’ll need your home equity in the future. A reverse mortgage may not make sense if you’ll need your home equity in the future to purchase another home or move into a nursing facility. Remember, the purpose of a reverse mortgage is to convert home equity into cash. A reverse mortgage will gradually reduce your equity over time, leaving you with less equity available for other purposes in the future.
How to Qualify
If you’re married, only one spouse needs to be at least 62. The other spouse can potentially qualify as a non-borrowing spouse.
Before 2014, there were very few credit and income requirements to get a HECM reverse mortgage. It was possible to qualify with zero income and terrible credit. Unfortunately, this contributed to a growing default problem (due to nonpayment of property charges) that resulted in losses for the FHA insurance fund. To address the problem, HUD implemented new lending guidelines called financial assessment. Today, you must meet certain income and credit requirements to qualify for a HECM.
Though HECM lending guidelines are tighter than they used to be, they’re still generally less stringent than traditional “forward” mortgage guidelines. Again, you don’t need perfect credit and tons of income to qualify. You simply need to pass two financial assessment “tests” called financial ability and financial willingness.
The financial ability assessment is based on residual income. Residual income is the money left over once you’ve paid all debt payments (excluding the mortgage paid off by the reverse mortgage), property taxes, homeowner’s insurance, HOA dues, etc. The residual income calculation also takes into account the number of people living in your home and a utility and maintenance estimate. If you’re short on residual income, you may still be able to qualify with certain compensating factors.
The financial willingness assessment is based on credit and how well you pay the required property charges. Do you have a history of paying your bills at least reasonably well? Are there any serious derogatory credit items on your credit report, such as bankruptcies, foreclosures, chargeoffs, or collections?
Again, you do not need perfect credit to pass the financial willingness assessment. If you don’t pass financial willingness, you may still be able to qualify by documenting an extenuating circumstance.
Life expectancy set-aside (LESA)
If you fail financial ability or financial willingness and you’re unable to document a compensating factor or extenuating circumstance, respectively, you may still qualify. Your lender may still approve your loan with a life expectancy set aside (LESA).
The following property types are eligible for a HECM:
- Single-family residences (SFR)
- Multiplexes (up to 4 units)
- Condominiums in FHA-approved complexes
- Manufactured homes (built after June 15, 1976 and at least doublewide)
The following property types are not typically eligible for a HECM:
- Commercial properties, including active farms, daycares, and bed and breakfasts
- Highly unique properties, such as hangar homes, dome houses, barndominiums, and berm homes
- Singlewide manufactured homes
- Manufactured homes built before June 15, 1976
- Mixed-use properties where commercial makes up half or more of the property
HECM lenders required an appraisal by an FHA-certified appraiser as part of the HECM application process. Your home doesn’t need to be in perfect condition, but it should be free of major safety issues and deferred maintenance. Minor repairs are typically not a hindrance to approval and can often be completed during the application process.
If you have any concerns about your credit, you may wish to pull a credit report on yourself before applying for a reverse mortgage. Per federal law, you can obtain a free credit report yearly at annualcreditreport.com.
HECM Ongoing Costs
The HECM is a home loan, so naturally, it comes with an interest rate. HECM rates vary with conditions in the financial markets, but they’re typically comparable to or slightly higher than traditional 30-year fixed mortgage rates.
The note rate on a HECM is called the initial interest rate (IIR). The initial interest rate is an annual rate, but interest accrues monthly. No mortgage payments are required, so the unpaid interest simply accrues onto the loan balance over time.
Annual mortgage insurance premium (MIP) also accrues onto the loan balance over time. Similar to interest, MIP accrues monthly based on an annual rate.
FHA uses the funds raised by MIP (and IMIP) to fund the Mutual Mortgage Insurance Fund, which insures HECMs. Remember, the HECM is a non-recourse loan. The most you will have to pay back is the value of the home, even if it’s not worth enough to pay off the entire balance.
Let’s check out an example to see how interest and MIP accruals work. Let’s assume an initial interest rate of 4.5% and a loan balance of $100,000 to keep the numbers simple. MIP is currently 0.50% annually, so the total interest rate (initial interest rate plus MIP) is 5% annually.
To calculate total interest and MIP accruals for the current month, we need to first calculate the monthly total interest rate:
5% (IIR + MIP) / 12 months = 0.41667% (monthly rate)
We then multiply the total interest rate by the loan balance to calculate the monthly total interest due:
0.41667% (monthly IIR + MIP) * $100,000 (balance) = $416.67 (interest due)
As you can see, the calculation for the monthly total interest, which equals $416.67, works the same as it does for a traditional “forward” mortgage. The difference, of course, is that the HECM requires no monthly payments as long as you remain in good standing. Any unpaid total interest is simply added to the loan balance:
$100,000 (starting balance) + $416.67 (interest and MIP due) = $100,416.67 (new balance)
The lenders use the new loan balance of $100,416.67 to calculate interest and MIP accruals for the following month.
If you’re concerned about the loan balance increasing over time, it’s possible to make occasional interest payments. Occasional interest payments would likely still be cheaper than an actual mortgage payment and would help keep the loan balance down.
Closing costs for a HECM reverse mortgage are one-time charges at closing to cover the services necessary to complete your loan.
- IMIP – A one-time fee charged at closing by FHA to insure the HECM. IMIP helps make the HECM non-recourse.
- Origination fee – A one-time fee charged by lenders. Lenders may occasionally be willing to negotiate this fee, particularly if your starting loan balance is relatively large.
- Third-party costs – One-time fees are charged to cover third-party services necessary to complete your loan. Common third-party costs include title insurance, appraisal, government recording, credit report, etc.
If you’re purchasing with a HECM, you’ll need to cover the closing costs out of pocket along with your down payment.
There’s no set amount of closing costs that apply to every HECM. Closing costs vary widely depending on the lender, loan amount, location, and conditions in the financial markets. If your initial loan amount is large, the lender may have some margin to cover some or all of your costs with a lender credit. We recommend consulting with a licensed reverse mortgage lender for a firm closing cost estimate.
How Much Can I Get?
The HECM also tends to offer more money when interest rates are lower and less money when interest rates are higher. No set amount applies to everybody.
What we’ll cover next will be somewhat technical, but the goal is not for you to calculate HECM proceeds on your own. We have calculators for that, right? You’ll find links for our fantastic reverse mortgage calculators at the end of this guide. The goal of this section is to familiarize you with some of the terms and concepts you may encounter as you further investigate a reverse mortgage.
How Proceeds are Calculated
The total amount of money available from a HECM reverse mortgage is called the principal limit (PL). The principal limit is the total bag of money available before mandatory obligations are paid. To calculate the principal limit, we need to first establish two values: the maximum claim amount (MCA) and the principal limit factor (PLF).
The maximum claim amount equals the lesser of the home value or the FHA lending limit. For most people, the maximum claim amount equals the home value because most people own homes valued less than the lending limit.
If your home’s value is more than the lending limit, the maximum claim amount equals the lending limit. The lending limit effectively caps the home value for purposes of calculating the principal limit.
The principal limit factor comes from a table published by HUD. The lender determines the correct principal limit factor to use based on the age of the youngest borrower (or non-borrowing spouse) and the expected interest rate (EIR).
Lenders use the expected interest rate solely to determine the principal limit factor and calculate the principal limit. The expected interest rate is calculated by adding a base index rate (currently the 10-Year CMT) and a margin set by the lender. For example, if the index is 1.00% and the margin is 2.50%, the expected interest rate equals 3.50%.
To calculate the principal limit, the lender simply multiples the principal limit factor and the maximum claim amount.
For example, let’s assume a home value of $200,000 and a principal limit factor of 0.50 based on age and expected interest rate. Because the home value is less than the lending limit, the maximum claim amount equals the home value. The principal limit calculation works as follows:
$200,000 (MCA) * 0.50 (PLF) = $100,000 (PL)
As you can see, the principal limit factor is a loan-to-value percentage determined based on age and expected interest rate. In this example, the principal limit factor is 0.50, or 50% of the home value.
The Net Principal Limit
It’s important to understand that the principal limit is not your “walk away” money. Mandatory obligations such as existing mortgage balances, closing costs, set-asides, etc., are paid out of the principal limit. Once mandatory obligations are paid, the remaining funds (called the net principal limit) are available for allocation to line of credit, lump sum, and term/tenure income.
Reverse Mortgage Calculators
If you’d like to get an estimate of how much you can get from a reverse mortgage, check out our fantastic reverse mortgage calculator. We may be a little biased, but we think our calculator is the best available online. If you’re interested in a HECM for purchase, check out our reverse mortgage for purchase calculator. If you’d like to calculate a simple principal limit, then check out our principal limit calculator. Links to the reverse mortgage calculators will appear at the end of this guide as well.
If your head is spinning after reading this, don’t worry! You don’t need to thoroughly understand the calculations to benefit from a reverse mortgage. The intent is simply to expose you to reverse mortgage information and concepts you may encounter during the application process.
Finding Reverse Mortgage Lenders
If you decide to look into a reverse mortgage further and want to get a formal estimate, you’ll want to talk to a few lenders. Finding reverse mortgage lenders to work with is pretty easy. You can ask for referrals from friends, colleagues, neighbors, and relatives. A trusted real estate agent, financial adviser, or CPA may also be a good referral source. A lot of people have reverse mortgages, so it’s a good bet you know somebody who can give you a lender recommendation.
If you don’t know anybody who give a referral, try Googling top lenders or searching our reverse mortgage lender directory. Note that you don’t necessarily need to work with a lender located in your area. There are numerous national lenders licensed in your state.
A reputable lender will be a good source of reverse mortgage information and will take the time to learn about your financial goals. If the lender you’re talking with seems impatient or pushy, you may want to find another one to work with.
According to HECMWorld, the top 5 reverse mortgage lenders by loan volume (as of this writing) are:
If you’re not sure who to call, any of these lenders are probably a good place to start. Just make sure that the agent you work with patiently takes the time to explain the program and answer your questions. If you feel like you’re being pushed, you may consider trying somebody else.
Reverse Mortgage Counseling
If you decide to move forward with a reverse mortgage, the first step will be counseling. Reverse mortgage counseling is required by HUD when you apply for a HECM reverse mortgage. The purpose of counseling is to ensure that you understand basic reverse mortgage information and concepts. The counseling session is conducted by an independent third-party HUD-licensed counselor and usually costs around $125. Once the counseling is complete, you’ll be issued a certificate that you’ll need to provide to your lender.
You can easily find reverse mortgage counselors in your area or across the nation using our reverse mortgage counselors directory. Your lender may also be able to provide a list of counselors.
How a Reverse Mortgage is Repaid
Most of the time, a HECM is paid off as a result of a maturity event. Once a maturity event occurs, the reverse mortgage balance becomes due and payable in full. The most common maturity events are the sale of the property, default (usually from failure to pay the property charges), and the last borrower or non-borrowing spouse passing away.
The repayment process works just like a regular mortgage if the maturity event results from the sale of the property. Once the sale is complete, the reverse mortgage balance is paid through closing. Any remaining equity goes to the (now former) homeowner.
If the maturity event occurs because of death, the servicer will issue a Due and Payable notice to the heirs. The heirs will have a few different options to settle the reverse mortgage balance:
- Pay the lesser of the loan balance or 95% of the appraised value to keep the home. The heirs can settle the loan balance by refinancing or using other assets such as savings or life insurance proceeds.
- Sell the property, repay the balance, and keep the remaining equity. The sale process works just like it would with any other type of mortgage. You hire a real estate agent (or sell it yourself, if you prefer), sell the house, and repay the loan balance once the sale closes. Any remaining equity goes into the estate.
- Give the lender a Deed in Lieu of foreclosure. The heirs sign the deed over to the servicer and the servicer sells the property and repays the loan balance.
- Do nothing. The lender uses the foreclosure process to sell the property and repay the loan balance.
HUD requires the lender to begin foreclosure proceedings if the heirs do not repay the balance in response to the Due and Payable Notice. Foreclosure must begin within 90 days, but no sooner than 30 days after the issuance of the Due and Payable Notice.
The word “foreclosure” comes with negative connotations, but it’s a normal part of settling up many reverse mortgages if the borrowers pass away and there are no heirs who want to keep the house. A reverse mortgage foreclosure is not necessarily the same thing as a traditional “forward” mortgage foreclosure, which commonly result from hard economic times and inability to make mortgage payments.
I’ve heard and read conflicting information about the initial timeframe the heirs have to settle the loan balance and keep the property. Some say the initial time window is 90 days. Others say six months. The ambiguity probably means servicers have some flexibility here. I think it’s safe to assume that the heirs have as much as six months to repay the loan and keep the property.
Of course, keep in mind that the servicer must start foreclosure by the 90-day mark. If the foreclosure process moves quickly, the servicer may complete it before six months have passed. It’s in the best interests of the heirs to repay the loan balance as quickly as possible if they intend to keep the home. It’s also in the best interests of the heirs to be in regular communication with the servicer about their intentions.
If the heirs plan to sell the home, they have an initial time window of six months to do so. If the heirs are diligently trying to sell the home, but are unsuccessful, they can request up to two 90-day extensions to push back foreclosure. In other words, the heirs could have as long as a year to sell the home before HUD requires the lender to foreclose.
It’s important to understand that the heirs do not lose out simply because the lender begins foreclosure proceedings. HUD requires lenders to being foreclosure by a certain date, but it doesn’t mean foreclosure is a done deal. The foreclosure process stops once the heirs repay the loan balance or sell the home.
Heirs shouldn’t neglect to inform the servicer when the last borrower or non-borrowing spouse passes away. Lender are subject to strict regulations from HUD, so they monitor various data sources for death notifications. The process of settling the loan balance begins based on the date of death, not the day the lender learns about the death.
Reverse Mortgage Calculators
If you’d like to get an estimate of how much reverse mortgage lenders may be able to offer you, check out our fantastic reverse mortgage calculator. We may be a little biased, but we think our calculator is the best available online. If you’re interested in a HECM for purchase, check out our reverse mortgage for purchase calculator. If you’d like to calculate a simple principal limit, then check out our principal limit calculator.
If you’d like additional news and information about the HECM reverse mortgage, we can recommend the following resources:
- The Reverse Mortgage Revealed, by Mike Roberts, Founder of MyHECM.com
- Wade Pfau’s Retirement Researcher Website
- Jack Guttentag’s Mortgage Professor Website
- National Reverse Mortgage Lender’s Association
- Department of Housing and Urban Development