What is a HECM loan? How does it work? How can it help empower your retirement? A highly experienced industry veteran explains the ins and outs of how this unique loan product can potentially empower your retirement.
I’ve helped many seniors get a HECM over the years, including a very close family member. I’ve also published a book about it. I’m a big fan, but I’m not here to try and sell you one. My goal is to give you an unbiased rundown of how this unique loan product can potentially empower your retirement.
I can tell you right now that much of what you’ve heard about the HECM program is either dated or simply not true. Rumors and misconceptions are rampant. In this guide, we’ll separate fact from fiction so you can decide if this is the right solution for you.
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What is a HECM Mortgage?
The HECM meaning is home equity conversion mortgage, which is the most popular reverse mortgage in the United States.
Congress created the HECM program for seniors (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. Today, it’s regulated by the Department of Housing and Urban Development (HUD) and insured by the Federal Housing Administration (FHA).
The minimum qualifying ageis 62. If you’re married, only one of you needs to be at least 62. The younger spouse can qualify as a non-borrowing spouse.
The HECM program for seniors was created to give homeowners access to home equity without a mortgage payment or giving up ownership of your home.
How Does a HECM Loan Work?
So, how does a home equity conversion mortgage work? First of all, it’s the opposite of what you’re used to. With a traditional “forward” mortgage, you borrow a large amount up front and pay it back over time with monthly payments. Your loan balance decreases and your home equity increases over time.
A HECM mortgage works in the opposite direction. You borrow over time and pay it back in one lump sum when you’re no longer living in the home. The idea is to convert home equity into cash that you can use to fund your retirement.
If you’re at least 62, a HECM enables you to convert home equity into cash without a mortgage payment and without giving up ownership of your home.
No repayment is required as long as at least one borrower (or non-borrowing spouse) lives in the home, maintains it, and pays the property taxes, homeowner’s insurance, and HOA dues (if applicable).
You remain the owner of your home and you’re free to leave it to your heirs. Your heirs can keep the home by paying off or refinancing the home. If they don’t want the home, they can sell, pay off the reverse mortgage, and keep any remaining equity.
Your heirs can also let the lender sell the home if they won’t want to keep it or mess with selling it.
The HECM is a non-recourse loan, which means that FHA will cover any shortage if you owe more than the home is worth at the time of repayment.
Proceeds have no impact on income taxes, Medicare, or Social Security retirement benefits.
If you’d like more information about how the loan works, check out the video below.
What is a HECM Reverse Mortgage Used For?
The HECM is versatile and customizable, so it can be used to accomplish a lot of things. Your lender can tailor it based on your individual financial needs and goals.
Proceeds are available as a lump sum, line of credit, monthly income, or some combination of all of these options. Seniors commonly use the proceeds to:
- Eliminate existing mortgage payments
- Eliminate other debts, such as credit cards, medical bills, and auto loans
- Finance home improvements
- Pay for medical bills
- Supplement retirement income
- Increase liquid retirement assets
- Set up a rainy day or emergency fund
- Plan for long-term care
You’re free to use the funds for whatever you like.
You’re also free to restructure your HECM years down the road with a phone call to your lender. For example, if you need to change your line of credit into a monthly paycheck, you can do that quickly and easily by calling your lender and paying a nominal $20 change fee.
HECM for Purchase
Many seniors also use a HECM to finance a home purchase without a mortgage payment. In my opinion, this is one of the best-kept secrets of the mortgage industry. There are two great reasons to finance a home purchase this way:
- Increased purchasing power – You don’t need to pay cash to avoid a mortgage payment. The lender can finance part of the purchase price, which means you can purchase more home than you could otherwise afford with just cash.
- Keep more cash in the bank – Because you can finance part of the purchase price, you don’t need to pay 100% cash to avoid a mortgage payment. This keeps more cash in the bank to fund your retirement.
How this works is pretty simple: you bring your down payment (plus any closing costs) and the bank finances the rest with no monthly mortgage payment. Your obligation is to live in the home and pay your property charges.
The down payment for a purchase HECM varies depending on age, home purchase price, and current interest rates. If you’d like to estimate a down payment, check out our purchase calculator.
A home equity conversion mortgage is best for seniors who don’t plan to move anytime soon, but it doesn’t keep you from moving in the future if you need to. You’re not locked into your home when you get a HECM. If circumstances change and you need to sell in the future, you’re free to do so. There are no prepayment penalties or limitations on selling.
Upfront and Ongoing Costs
A HECM is a home loan, so there are costs associated with getting one. The costs fall into two buckets: interest and closing costs. We’ll cover more details on both next.
Interest and MIP
The HECM is a home loan, so it comes with an interest rate. HECM reverse mortgage rates vary based on market conditions, but they’re usually comparable to traditional “forward” mortgage interest rates.
The note rate on a HECM is called the initial interest rate (IIR). The initial interest rate is an annual rate, but the interest accrues monthly – which is the same way interest accrues on a “forward” mortgage. No payments are required, so any unpaid interest simply accrues onto the loan balance over time.
FHA also assesses it’s own mortgage insurance premium on top of the initial interest rate. This premium, which is called annual mortgage insurance premium (MIP), works just like the initial interest rate. It’s based on an annual rate with accruals on a monthly basis.
The annual mortgage insurance premium is important because it helps make the HECM non-recourse.
Like any home loan, a HECM typically has at least some closing costs. The closing costs can be pricey (but not always), which is why they’re one of the most common objections raised by applicants. However, I think they’re well worth it for most borrowers.
Closing costs generally fall into three categories:
- IMIP – A one-time fee charged at closing by FHA. IMIP helps make the loan non-recourse.
- Origination fee – A one-time fee charged by lenders. Lenders are often willing to negotiate this fee, particularly if your starting loan balance is relatively large.
- Third-party costs – One-time fees that are charged to cover the third-party services necessary to complete your loan. Common third-party costs include title insurance, appraisal, government recording, credit report, etc.
Most or all of the closing costs are typically rolled into the new loan balance, which means you don’t have to pay them out of your pocket. The exception is buying a home with a HECM, which requires that you pay the closing costs out of pocket along with your down payment.
How to Qualify
In the past, there were very few income and credit qualifying requirements. You could have terrible credit and zero income and still qualify.
FHA has since implemented new qualifying guidelines to limit defaults due to nonpayment of property taxes, homeowner’s insurance, and HOA dues (where applicable). These days, lenders are required to evaluate your credit and income as part of the application and approval process.
This is why a HECM is not a loan of last resort for the broke and desperate – contrary to popular perception. You have to qualify. The broke and desperate commonly don’t qualify because they have limited income and severely damaged credit.
A home equity conversion mortgage is best used not as a life raft, but as a safety net. The best candidates are those who are at least reasonably financially stable.
The lending guidelines are tighter today than in the past, but it’s still relatively easy to qualify. You don’t need to have a lot of income and you don’t need to have perfect credit. In fact, lenders don’t even care about your credit scores.
Lenders are mainly concerned with the following:
- Payment histories on debts and property charges: It’s OK to have a few late payments here and there as long as there aren’t too many of them. Lenders are most concerned with your payment histories for property taxes, homeowner’s insurance, and HOA dues (if applicable). It’s extremely important that you’ve paid your property charges on time.
- Residual income: Your lender wants to make sure you have a certain amount of income left over at the end of the month after paying your property charges, debt payments, and estimated utilities.
You may still qualify if you don’t meet the payment history or residual income requirements. Lenders have flexibility to still approve your loan by documenting certain compensating factors or extenuating circumstances that offset the derogatory credit and/or income shortfall, respectively.
If you don’t have valid compensating factors or extenuating circumstances, you may still qualify with a life expectancy set-aside (LESA).
You don’t need to have perfect credit to qualify for a HECM. As long as you pay your bills reasonably well and have at least some income, you can likely qualify just fine.
How Much Can You Get?
There is no set amount that every applicant receives. How much you qualify for depends on your age, home value, current interest rates, and the HECM program you select.
Older borrowers tend to qualify for more than younger borrowers. The HECM also tends to offer more money when interest rates are lower and less money when interest rates are higher. Again, no set amount applies to everybody.
If you’d like an estimate of how much you can get, check out our fantastic HECM calculator. It’s free to use and no contact information is required.
What is the difference between a HECM mortgage and a reverse mortgage?
A HECM mortgage is a reverse mortgage. It’s the most common reverse mortgage product in the United States.
Who owns the house in a reverse mortgage?
You do! You always remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in your home. It’s fundamentally just a home loan.
How do you pay back a reverse mortgage?
A reverse mortgage can be paid back at any time with no prepayment penalty. You can pay it off by refinancing it, paying it off with cash, or paying it off as part of the sale of the home.
How much money do you get from a reverse mortgage?
How much you get varies, depending on age, home value, current interest rates, and the type of reverse mortgage you go with. You can get an estimate using our reverse mortgage calculator.