You’ve probably seen the ads with celebrity spokespeople extolling the benefits of a home equity conversion loan. But what is a home equity conversion loan? How does it work? Is it a good idea to get one? I’m an experienced industry veteran and I’ll be answering some of these questions for you.
What is a home equity conversion loan?
A home equity conversion loan is better known as a home equity conversion mortgage, or HECM. The HECM is designed to give homeowners 62 or older access to a portion of their home’s value without a mortgage payment or giving up ownership of the home.
You always remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit the remaining equity in the home whether they choose to keep it, sell it, or let the lender sell it.
The HECM is a non-recourse loan; the most that will ever have to be repaid is the value of the home. If the home isn’t worth enough to settle the entire balance, FHA covers the shortage from the Mutual Mortgage Insurance Fund.
Because the HECM is a home loan, interest accrues on the money you borrow (like any other home loan). If no mortgage payments are made (the whole point, right?), the interest simply accrues onto the loan balance over time.
HECM interest rates are typically comparable to 30-year rates for traditional “forward” mortgages.
Highly versatile and customizable
The HECM is highly versatile and can be tailored to your financial goals. Proceeds can be received as a line of credit, lump sum, monthly term or tenure payments, or some combination of all of these options. HECM borrowers commonly use the proceeds to:
- Eliminate an existing mortgage payment
- Eliminate other debts, including credit cards and auto loans
- Do home improvements
- Supplement retirement income
- Pay off medical bills
- Supplement liquid retirement assets
- Set up a rainy day or emergency fund
- Do fun stuff, including travel
As you can see, the HECM can be used for just about anything you like. Again, no mortgage payments are required (as long as you meet your program obligations) and you always remain the owner of your home.
There’s a lot of misconceptions and misinformation floating around out there about the home equity conversion loan. Even reputable pundits and media outlets constantly get it wrong. The following are some of the most common myths and misconceptions you may have heard:
Myth #1: “I’m losing ownership of my home.”
This is probably one of the most common misconceptions I’ve heard. A reverse mortgage is simply a home loan. You’re not selling your home to the bank. You always retain title ownership of the home.
Myth #2: “I’m selling my home to the lender for a discount”.
The HECM reverse mortgages offers a portion of your home’s value based on your age, prevailing interest rates, and the program you select (variable-rate HECM or fixed-rate HECM). Because it offers a portion of the home value, many people think they’re selling their house to the bank for a discount. Again, a HECM is simply a home loan. You retain title ownership of the home. If you sell the home in the future, the reverse mortgage will be paid off through the proceeds of the sale and you will receive the remaining equity. This is exactly how it works for a traditional “forward” mortgage as well. You’re not selling your home and you’re certainly not selling your home for a discount.
Myth#3: “Only broke and desperate people should get a reverse mortgage as a last resort.”
Definitely not. Broke and desperate people often don’t meet the credit and income requirements of a HECM reverse mortgage. The guidelines aren’t terribly stringent, but you still have to qualify for a home equity conversion loan.
Myth #4: “I will use up all of my home equity.”
A reverse mortgage can use up all of your home equity, but it doesn’t mean it will. Yes, a reverse mortgage is intended to convert equity into cash, which means your loan balance rises over time. However, it’s also designed to preserve equity. It’s not a financially viable program if it uses up your equity quickly. Remember, the HECM is a non-recourse loan insured by FHA. This means the FHA insurance fund covers the shortage if there’s not enough value in your home to settle the entire loan balance at the time of repayment. For the program to be financially sustainable, it has to preserve equity as well.
Myth #5: “I’m leaving a big debt for my heirs to clean up.”
Again, the reverse mortgage is a non-recourse loan insured by FHA, which means that you’re not leaving a big mess for your heirs to clean up. If there’s not enough value in the home to pay off the entire loan balance, your heirs are not on the hook for the shortage. The most that ever has to be paid back is the value of the home.
Myth #6: “Reverse mortgage interest rates are sky high.”
Not at all. In fact, HECM rates are usually comparable to traditional 30-year fixed mortgage rates. This is possible because FHA insures the loan, which reduces risk for the lender and results in lower rates for borrowers.
Myth #7: “The fees are high.”
This is true sometimes, but not all the time. If you live in a high value home, it’s possible the fees could be high because of the IMIP charged by FHA. However, lenders often have some leeway to chop or eliminate their origination fee and/or cover third party fees if you’re starting off with a larger loan amount. If your home is less expensive and you have little to no mortgage balance to pay off, your closing costs may be fairly comparable to a traditional “forward” mortgage.
Myth #8: “The bank gets my house after I die.”
Definitely not. Remember, you remain the owner and you’re free to leave the home to your heirs. If your heirs wish to keep the home, they need to either pay off or refinance the reverse mortgage balance. If they don’t wish to keep the home, the bank will sell the home, pay back the reverse mortgage balance, and the remaining equity goes into your estate.
Myth #9: “As long as I’m 62 and have equity in my home, I will qualify for a HECM reverse mortgage.”
Unfortunately, it’s not that simple. There’s more to qualifying than just having equity in your home and being 62 or older. Today, lenders have to evaluate your income and credit through a process called financial assessment. The home also needs to be in at least decent condition with no major repairs needed.
Myth #10: “I can’t ever sell my house. I’m locked in for the rest of my life.”
Not at all. A reverse mortgage is best suited for seniors who don’t plan to move, but you’re free to move if you need to. You simply sell the home, pay off the balance with the proceeds of the sale, and keep any remaining equity. Selling works exactly the same way it would it you had a traditional “forward” mortgage.
Myth #11: “I can’t take any long trips or temporarily go into a nursing home or I might lose my house.”
Not at all. Yes, you need to live in the home, but it doesn’t mean you can’t take a long trip or stay in a nursing home for a few months. As long as you live in the home for the majority of the year and it remains your primary residence (not a second home or rental), you should be fine.
Myth #12: “I don’t need it now. I can just wait and get a reverse mortgage when I really need it.”
Don’t count on it. It’s actually gotten tougher to get a reverse mortgage in recent years. FHA has tightened the qualifying standards to reduce defaults due to nonpayment of property charges. You may not qualify in the future if your financial situation or the condition of your home deteriorates. The following factors could make a reverse mortgage less workable:
- Higher interest rates – A reverse mortgage offers more money when rates are lower. If rates rise in the future, you may not qualify for as much money as you do today. If you’re trying to pay off a large mortgage, higher rates could make it impossible to get enough to cover your entire current mortgage balance.
- Lower property values – Many real estate markets across the country have seen big increases in home values over recent years. If you’re in one of those places, your market could be ripe for a correction. If home values fall, you’ll qualify for less.
- Deterioration in your credit or financial profile – FHA rolled out new financial assessment guidelines in 2014 that require lenders to take into account your income, expenses, and credit history. If you incur debt or big medical bills that damage your credit, you may have difficulty qualifying.
- Deterioration in the condition of your home – We all know that homes take maintenance over time. If your financial situation is tight and you can’t keep up with the maintenance of your home, it may be tough to get a reverse mortgage in the future. Your home doesn’t need to be perfect, but it does need to be in at least reasonably decent shape to qualify.
The time to get insurance is not when your home is already burning down, right? If you qualify today and the reverse mortgage truly helps you, take advantage of it today. There’s no guarantee it will be available to you in the future
Is a reverse mortgage right for you?
A home equity conversion loan is a great financial solution, but it’s not necessarily perfect for everybody. There are some scenarios where a reverse mortgage may not make sense:
- You plan to move in the near future. Though there is no limitation on selling and moving, but the program is better suited for seniors who plan to stay in their homes for the foreseeable future. Reverse mortgages typically come with at least some closing costs, so you want to make sure you’re in the loan long enough to benefit from it and justify the costs.
- You desire to pass the maximum equity possible to your heirs. The reverse mortgage is designed to convert equity into cash over time, so if your goal is to preserve or build as much equity as possible, then it obviously doesn’t make sense for you.
- You have young children or a individual with disabilities living with you and you want them to continue living in the home when you pass. The reverse mortgage becomes due and payable once the last borrower has passed away or permanently moved out of the home. If you have other people living with you who won’t be capable of paying off or refinancing the reverse mortgage, they could be forced out of the home. However, you may be able to protect against such a situation with life insurance or other assets adequate to pay off the reverse mortgage balance.
However, if you’re over 62, a homeowner, and you plan to live in your home for the foreseeable future, a HECM reverse mortgage could substantially improve your retirement lifestyle and financial security.