Mortgages

What Does HECM Mean

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 12 minute read

There are a lot of retirees who are barely getting by month-to-month. They also frequently have tens of thousands of dollars in equity in their property. Meanwhile, their mortgage payment raises their ongoing monthly outlay.

For those who have house-rich but cash-poor situations, a reverse mortgage can be an excellent solution. However, you should weigh the pros and downsides well before committing to one, as they aren’t appropriate for everyone.

What Is a Loan for Reverse Mortgages?

Homeowners 62 and older can get access to cash through a reverse mortgage loan without having to make regular payments.

How It Works

Reverse mortgages are a way for seniors to access their home equity without having to make monthly mortgage payments, which can be a significant source of financial stress in retirement.

Homeowners can access their loan funds however they see fit. Your reverse mortgage can be disbursed in a single lump sum, in monthly installments, or as an ongoing line of credit, similar to a HELOC (HELOC). Like any other loan, interest paid on student loans is tax-free.

Mortgage liens are placed on the property by lenders. The debt must be repaid in full upon the homeowner’s death or the sale of the property. When a homeowner dies, the mortgage company often takes title to the property. 

If the sale of the property does not generate enough money to cover the loan in full, however, the lender cannot seek a deficiency judgment against the homeowner or their estate. Paying down the mortgage at any time will allow the homeowner or their heirs to keep the property.

This contract allows you to stay in the house indefinitely without having to make any further payments.

Naturally, loan providers do not hand away cash for anything. Interest is still accrued on the loan, but it is deducted from the payments they make to you rather than being added to your own repayments. The interest rate is variable rather than fixed if you take up a loan with monthly installments or a credit line. A one-time origination fee, or points, will also likely be required.

Example of a Reverse Mortgage

Let’s say your mortgage is $100,000 and your home is worth $300,000. The bank is willing to provide you with a $150,000 reverse mortgage. You can use the new loan proceeds ($150,000) to pay off the old mortgage ($100,000) and still have $50,000 left over.

Then, you can choose from the following payment options:

  1. Accept the fifty thousand dollars in a single, quick cash payment at the closing. You are free to do what you want with the money. There are, once again, zero tax ramifications.
  2. Have the reverse mortgage lender pay you $50k over 12 monthly installments. In contrast to a standard mortgage loan, your outstanding balance will increase when the bank sends you payments. In the event that you live long enough to collect all fifty thousand dollars, the payments will stop.
  3. The $50,000 should be treated as a revolving credit line from which you can make withdrawals as needed. You will be charged interest on the outstanding balance, just like with any other home equity line of credit.

Consider investing the fifty thousand dollars in a mix of the possibilities listed above.
With a reverse mortgage, you will never have to make payments toward the loan’s principal or interest.

What Sets Reverse Mortgages Apart From Regular Mortgage Loans

It’s hard to wrap one’s head around reverse mortgages because they function in the other direction of conventional home loans. It’s important to remember that reverse mortgages are unique in a few ways as you think about getting one.

Credit History Is Irrelevant

The loan’s underwriting and interest rate have nothing to do with your credit score or financial standing. Not like you owe anyone anything!

The Lender Gets Repaid at the End of the Loan Term

Because you haven’t been making your mortgage payments, the lender will get their money back when you either sell the house or leave the area. As long as you use the property as your primary residence, you are permitted to keep it under the terms of your lease.

When Your House is Turned Into a Rental, You Can’t Keep Your Reverse Mortgage.

In order to generate passive income during retirement, some people choose to invest in rental houses. Many people consider getting a reverse mortgage on their home, selling it, and then renting it out as a way to eliminate their monthly mortgage payment, access their home’s equity, and earn some extra money.

Unfortunately, you cannot leave your house before the reverse mortgage is paid in full. This would be a breach of the loan agreement and would give the lender grounds to terminate the loan.

If you’ve had your mortgage for at least a year and plan on moving out before the debt is paid off, you can do so without having to pay the loan off in full.

Less LTV Than With Conventional Mortgages

The repayment timeline for a conventional loan is laid out in detail and is known as the amortization schedule. As a result, the loan-to-value ratio permits some creditors to extend the financing for an amount equal to the full market value of the collateralized property (LTV).

Investors in reverse mortgages have no idea when they will see their money again. That’s why the loan-to-value ratios (LTV) they offer are so low, often between 50% and 65%.

Greater LTV When the Oldest Borrower is Older Than the Youngest

As a starting point for their calculations, lenders look at the youngest borrower’s actuarial life expectancy. The debt won’t be paid off, however, until the property is no longer occupied by any of the original owners. 

The loan’s principal is due in full if the borrower dies before the projected end of life, while the loan term is extended for as long as the owner lives beyond what the actuarial tables predict.

Programs for Reverse Mortgage Loans and Eligibility

Reverse mortgages provide homeowners with a lot fewer choices than standard mortgages do. In reality, the Federal Housing Administration’s (FHA) loan program is the most common option for borrowers of reverse mortgages. However, you shouldn’t be astonished if reverse mortgages continue to develop and expand in the coming years.

Mortgage for Home Equity Conversion from FHA

The FHA Home Equity Conversion Mortgage (HECM) lending program is the most common type of reverse mortgage.

The following conditions must be met to qualify:

  • Those seeking a loan must be 62 or older.
  • Borrowers are required to use the property as their principal residence.
  • Either a single-family home, a multifamily residence with two to four units or a condominium that meets FHA standards is acceptable.
  • To ensure they fully grasp the HECM loan’s financial commitments and legal ramifications, borrowers are required to undergo a counseling session approved by the U.S. Department of Housing and Urban Development (HUD).
  • The ability to pay regular maintenance, property taxes, and insurance premiums is a prerequisite for obtaining a loan.

As of the year 2021, the HECM program’s maximum mortgage loan limit is $822,375. In spite of the low LTV, mortgage insurance is still required because the loan is an FHA loan. 

There will be an origination fee equal to 2% of the total loan amount ($2,000 for every $100,000 borrowed). Moreover, borrowers are obligated to pay a 0.5% annual premium toward the FHA’s MIP, which is added on top of their monthly principal and interest payments.

However, HECM loans are not offered by all mortgage companies. Finding local lenders or brokers to help you close these loans may require some research.

EquityAvail Program by Finance of America Reverse

EquityAvail, a hybrid reverse mortgage program, was recently introduced by Finance of America Reverse, a specialty lender.

Borrowers receive a one-time lump amount from the program, and then make monthly payments to the lender for 10 years; these payments are lower than those required by a standard mortgage loan, though. 

After ten years, the borrower is no longer responsible for making mortgage payments, and they can stay in the home rent-free until they either leave, sell, or perish. EquityAvail has various advantages over traditional HECM loans. 

To start, it eliminates the need for mortgage insurance, which saves money for borrowers. Also, because borrowers do make payments for the first 10 years, anyone younger than 60 can become a borrower.

A growing number of baby boomers are reaching retirement age, which could lead to a rise in the popularity of hybrid reverse mortgages in the future years.

The Pros of Reverse Mortgages

There are many reasons to take out a reverse mortgage while you’re retired. The following should be taken into account when deciding if a reverse mortgage is a right choice for your financial and estate planning needs.

  • While you’re a resident, you won’t have any monthly payments to worry about. Your monthly costs for a living can be drastically reduced in this way.
  • Infinite Residency. The borrower is responsible for repaying a reverse mortgage loan only upon leaving the property, passing away, or selling the home.
  • You and your Heirs are protected from financial loss should the value of your property decline and you fall upside down on your mortgage. If the lender does not get the full payback amount, they cannot file for a deficiency judgment against you or your estate.
  • Reverse mortgages can be paid off at any time, allowing you or your heirs to maintain ownership of the home. The loan provider does not automatically take ownership of the property upon your passing.
  • Reverse mortgage lenders do not use credit scores as a qualification criterion for making loans. As long as you complete the other qualifications for the loan, personal bankruptcy or other negative credit history is not going to prevent you from getting a reverse mortgage.
  • You have the freedom to access your equity in a variety of ways, including a single lump sum, regular monthly payments over a certain period of time or dollar amount, a revolving line of credit, or some combination of these.

The Cons and Pros of Reverse Mortgages

All forms of financial investment carry the possibility of loss. Everybody would be using them if that weren’t the case. Before signing any paperwork for a reverse mortgage, it’s important to weigh the pros and cons.

  1. A reverse mortgage is only available to people who actually live in the home. In contrast to conventional mortgages, you won’t be able to rent out your home if you decide to leave. Neither can you enter a care home and keep your home without paying off your reverse mortgage.
  2. Lenders often set the maximum LTV (loan-to-value ratio) at between 50% and 65%. Since the lender has no recourse if the loan goes underwater, this is a disadvantage of a non-recourse loan.
  3. Borrowers must be 62 or older to qualify for a HECM reverse mortgage.
  4. Reverse mortgage interest is not tax-deductible until the loan is paid in full, limiting the tax benefits of this lending option. However, for many people, it doesn’t happen until after they die, which is obviously too late to be of any assistance. However, because the standard deduction is now much larger thanks to the Tax Cuts and Jobs Act of 2017, fewer Americans will need to worry about this because they will no longer need to itemize their deductions.
  5. In order to qualify for a HECM loan, borrowers must pay a mortgage insurance premium to the Federal Housing Administration (FHA) equal to 2.0% of the loan amount upfront and 0.5% of the loan amount year thereafter.
  6. Loan applicants are required to complete a financial counseling program that has been approved by the HUD.
  7. Only a small fraction of banks and credit unions offer reverse mortgage loans, and even fewer offer a variety of reverse mortgage lending programs.
  8. Financial scams: Unfortunately, the elderly are common victims, particularly at the hands of loved ones, carers, and even some financial consultants. In the case of a reverse mortgage, a family member or caretaker could potentially use their power of attorney to apply for a loan and then steal the money. 
  9. Or, the advisor may recommend expensive items, like an annuity, that the senior can only buy if they take out a reverse mortgage, and the advisor may even profit from this arrangement by accepting an unlawful kickback from the mortgage lender.

Timing of Foreclosure by Reverse Mortgage Lenders

Nonpayment is the most common reason for foreclosure, but it is not the only one.
Paying property taxes and homeowner’s insurance is a condition of receiving a loan. A breach of the mortgage note would occur if this were to not be done. 

However, if the borrower fails to reimburse the lender for them, the lender will file for foreclosure. In most circumstances, the lender will simply buy it for you and pass the expenses along to you in the form of increased interest and principal payments.

Foreclosure can also result from vacating the home without first paying off the reverse mortgage in full. Even if you’d like to stay in your own home as you age, you might wind up having to enter a nursing home or other long-term care facility instead. 

Should you decide to leave your current residence, you will be required to repay any outstanding balance on your reverse mortgage.

The borrower is responsible for the maintenance and upkeep of the property. As with other violations of the terms of reverse mortgage loans, neglecting necessary maintenance and repairs might result in the loan’s seizure.

Other Ways to Access Your Home’s Equity

For retirees who have equity in their homes but low savings, reverse mortgages are not the only option. Do not rush into a reverse mortgage without first exploring your other options.

Loans for Home Equity

A home equity loan is typically a second mortgage, but if you take out a loan on a house you already own outright, the loan is considered a first mortgage. A conventional forward mortgage often allows you to borrow 80-100% of the property’s worth. 

That’s great news since it means more money for you, but it also means more debt at a rate of interest you can’t afford.

Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is a revolving line of credit for up to the home’s equity worth, with interest that may rise or fall from month to month.

Borrower and lender can work out the loan’s terms and the possible quantity of credit by talking to one another. Before deciding, learn the differences between HELOCs and home equity loans.

Cash-Out Refinance

You can refinance your existing first mortgage without having to take out a second mortgage. A cash-out refinance is when a homeowner takes out a new mortgage loan for an amount higher than what is owed on the property, with the intention of keeping the difference.

When you take out a new mortgage, the amortization schedule resets and more of your payment goes toward interest than it did before. Additionally, it extends the time until the loan is paid off, which for the elderly may be the rest of their lives. However, this also means a greater LTV than with a second mortgage.

Compare the benefits of refinancing with those of alternative methods of getting cash out of your property before making a final decision.

Reverse Mortgages and Downsizing

Do you enjoy the notion of a reverse mortgage but want to downsize so that you can retire in a smaller, more affordable home? To avoid going through two settlements, the FHA’s HECM loan program also comes in a buy option a purchase settlement, and a refinance settlement.

At closing, you’ll need to bring in cash to cover the difference between the HECM loan amount and the purchase price of the home. If the purchase price of the new property is $300,000 and the net loan amount after settlement charges is $140,000, then the borrowers must bring $160,000 in cash to the closing table.

Although the monthly payments on a conventional mortgage on the new house may be less than the HECM, they are still required. In contrast, funding with a HECM mortgage necessitates more money upfront but removes future mortgage payments and the possibility of a drop in the home’s market value. 

Borrowers need to do the math to figure out what course of action will work best for them. Both minimum age and attendance at a therapy session approved by HUD remain in effect. 

Reverse mortgages are similar to traditional mortgages in that the borrower or his or her heirs have the option of paying down the loan debt at any time or giving the property to the lender following the borrower’s death.

Bottom Line

In the same way that a dividend-free stock or a bond with no coupon would deliver no cash to its owner, home equity does the same. Equity appreciation is dormant until the asset is sold or a loan is taken out against it.

Unfortunately, the equity that has been built up in the homes of the elderly who are still paying mortgage payments keeps growing. Having money in hand is often more useful than investing in a company’s stock.

With the help of a reverse mortgage, you can have the financial stability and peace of mind you deserve in your retirement years. Nonetheless, they are not without their own set of risks and drawbacks. A reverse mortgage comes with both responsibilities and rights, so it’s important to know what they are.

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