What Is a Home Equity Conversion Mortgage?

Definition and Example of a Home Equity Conversion Mortgage

A Home Equity Conversion Mortgage (HECM) is a government-insured reverse mortgage product. It allows people ages 62 and older to receive a loan based on the equity available in their home.

• Acronym: HECM

Borrowers can apply for a HECM through banks that offer them and that are approved by the Federal Housing Administration (FHA). Applicants are required to receive counseling from an approved counselor to learn more about these mortgages as well as their other options.

Let's say you have a home worth $400,000 and an existing mortgage with $25,000 remaining. Your lender determines you can get a HECM for $300,000. The HECM pays off your existing mortgage and you receive payment for the remaining amount. You don't have to make payments on the loan, but the interest due on the loan will increase the principal balance owed over time.

How Home Equity Conversion Mortgages Work

If you’re approved for a Home Equity Conversion Mortgage, your loan amount is determined by a combination of the amount of equity in your home, the youngest borrower’s age, and the current interest rate. You can choose to make payments during the term of the loan, but you don't have to.

You can choose to receive your HECM proceeds in a lump sum, in monthly payments, or as a credit line. If you choose to receive the amount in monthly payments, the balance on the loan will increase each month. If you choose a credit line, the loan will have an adjustable interest rate and the balance will increase whenever you draw money from it.

If you do not make payments, the accruing interest is added to the loan balance and the loan is paid off when the home changes ownership. That means your estate will pay off the loan when you die. If you sell the house, the loan will need to be paid off at that time.

How To Get a Home Equity Conversion Mortgage

Home Equity Conversion Mortgages are available from the same types of bank lenders that do conventional residential mortgages. As long as a bank is approved by the FHA, it should be able to do HECMs. Visit your usual branch to find out. If they do not offer them, ask for a recommendation.

The following items are the requirements to qualify:

• Pre-application counseling
• Borrower age of 62 or older
• Home used as primary residence
• Borrower approved as willing and able to make insurance and property tax payments
• Sufficient equity in the home
• Must live in a single-family home; one unit of a two- to four-unit home; a HUD-approved condominium; or a manufactured home that meets FHA requirements
• Borrower must not be delinquent on any federal debt

Pros and Cons of Home Equity Conversion Mortgages

Pros Explained

• Gives people access to a stream of income: For those with little or no income, a Home Equity Conversion Mortgage can provide a steady flow of funds to help with expenses.
• Allows people to tap into the equity of the home without selling: Borrowers can benefit from the value of their home without having to sell it first and use the proceeds.

Cons Explained

• Interest adds up quickly: HECMs can be problematic if the interest rate is high or if you only qualify for an adjustable rate. The accumulated interest adds up very quickly if you elect not to make payments, and there could be no equity left in the property by the time you want to or have to move. This means reduced assets for you and your heirs later on.
• Fees can add to your costs: You should also consider the fees. You have to pay for the pre-HECM counseling before you can even apply. When the loan originates, the lender can charge an origination fee of up to $6,000, although the fee is capped at this amount by federal law. Closing costs such as title insurance, appraisals costs, inspections, and recording fees add up quickly and can end up being four, or even five, figures. The FHA also charges an upfront fee for the mortgage insurance premium (MIP). Those are just the upfront costs. Annual or monthly servicing charges and MIPs are also charged and added to the balance of the loan.
  

Alternatives to Home Equity Conversion Mortgages

The HECM is one of three types of reverse mortgages. Each type is used by people who have paid down most of their home mortgage or own their home outright. The other two types are single-purpose reverse mortgages and proprietary reverse mortgages.

Single-Purpose Reverse Mortgages

Single-purpose reverse mortgages are offered by some state and local governments and nonprofit organizations. This type is less expensive than the other two, but can only be used for one purpose, such as home repairs or remodeling.

Proprietary Reverse Mortgages

Proprietary reverse mortgages are private reverse mortgages that aren't insured by the government. These programs are offered by banks, with their own sets of terms and conditions. You may be able to find a proprietary reverse mortgage with better terms and related fees than a HECM.

The main drawback of many proprietary reverse mortgages is that there is no government insurance of the collateral value. You may be required to pay down the loan as well if your home value goes down. The FHA insures HECMs so you don't have to make up the difference if the home value goes down.

Is a Home Equity Conversion Mortgage a Good Idea?

If you have a lot of equity in your home, few or no other assets, and need income or cash, a Home Equity Conversion Mortgage may work well for you. If you have other assets you can use or a good, steady income already, consider holding off on a HECM until you need it.