A reverse mortgage, specifically a home equity conversion mortgage (HECM), is a special type of mortgage that’s useful for a very specific type of older homeowner. A HECM loan is a good idea if you meet a list of criteria (we cover below), which depends on your age and financial situation. In this guide, we’ll cover everything you need to know in order to make this determination yourself.
Let’s get started!
Are HECM reverse mortgages a good idea?
In short, HECMs are a good idea for a select group of homeowners. Once you’ve determined you meet the legal requirements of a HECM, then you will need to decide whether a HECM is the right financing for you or some other home financial product (like a HELOC or home equity loan).
Generally speaking, a HECM is a good idea if you:
- have enough equity to cover the reverse mortgage fees, taxes, and monthly home costs
- want to age in place (ie, stay in your home)
- have an immediate use for the funds borrowed
- do not have heirs that you would like to inherit your home equity
- do not have a good enough credit score to qualify for other home financial products (this one is IMPORTANT! If you qualify for other financial products to access your home equity, then consider those first!)
Every homeowner’s financial situation is unique so it’s hard to draw a line in the sand on whether a HECM is a good or bad idea for you. Keep reading to build enough facts to come to your own conclusion.
A HECM refresher: What is HECM?
HECM is short for Home Equity Conversion Mortgage. It is a reverse mortgage program backed and insured by the US federal government (FHA and HUD). HECMs are also the most popular type of reverse mortgage.
What is a reverse mortgage?
A reverse mortgage is a home loan instrument (ie, a home loan) that allows homeowners 62+ years old to access the untapped equity in their homes. It differs from a “normal” mortgage in that you, the homeowner borrower, receives money from the lender instead of the other way around (that is, you do not need to pay the bank like with normal mortgages).
The homeowner (you!) can choose to receive your funds in the following ways:
- Monthly payments
- Lump sum amount
- Equity line of credit
- Any mix of the above!
Monthly payments are convenient for most borrowers and lenders. Once you have applied for and got approved for the program, you can use this cash for anything you desire; there are no restrictions on the use of the funds.
You are not required to pay back the funds until any of the following occurs:
- You sell the house
- You move (i.e., it has been vacant for more than 12 months)
- You die (sorry to be so blunt!)
Once any of the three occurs, the due amount is returned to the lender, along with any accrued interest
For now, you need to know there are three kinds of reverse mortgages. These are:
- Home equity conversion mortgage (HECM)
- Proprietary reverse mortgage (also called a “jumbo reverse mortgage”)
- These private reverse mortgages refer to loans given by a private lender. They are not backed or insured by the federal government.
- Private lenders prefer to grant proprietary reverse mortgages only to people with a strong credit history and low mortgage balance.
- Single-purpose reverse mortgage
- These are the least popular among the three. In this case, the lender is either the state, a local agency, or a non-profit agency, and the amount granted can only be used for a certain purpose, which you must get approved by the lender first.
What is the difference between a HECM and a reverse mortgage?
All HECMs are reverse mortgages, but not all reverse mortgages are HECMs. That’s because a HECM is a popular sub-type of reverse mortgages.
If you’re looking for some prominent identifiers of a HECM loan that make it unique, here’s what you need to know:
- HECM is the only type of reverse mortgage backed by the Federal Housing Administration (FHA) & Department of Housing and Urban Development (HUD).
- It is the only type of reverse mortgage that allows you to do anything with the money you acquire.
Since it is backed by the government, the interest rates applicable on mortgages are much lower. Also, even if you have the perfect profile for HECM, as of 2022, the home worth limit is $970,800. This means that if your home is worth more than that amount, the lender will cap the loan at that limit (if you need more funds, consider getting a private reverse mortgage instead).
What are the legal requirements of a HECM?
The first legal requirement of securing a HECM is that you should own the property fully or if you have a mortgage on the residence, it has a low loan-to-value ratio (LTV).
In addition, the government requires that you are able to afford the monthly costs of:
- Your property taxes
- Home insurance
- Home maintenance bills
You are also required to do a reverse mortgage educational training prior to closing on the loan. This ensures you know what you are getting into.
How do you pay off the HECM after death?
A home equity conversion mortgage is paid off automatically after death. That is, you don’t have to make any additional arrangements. Your family has the opportunity to sell the residence and pay back the lender or if they have the funds already, they can use those funds to pay off the home debt. The lender has a legal right in the home equity of the house that formerly belonged to the homeowner so as soon as s/he passes away, the lender would like its funds returned to them (with interest).
What is the average interest rate for HECM?
The interest rates applicable to HECM programs continue to fluctuate. It depends on the economic conditions of the country as well as the industry.
In April 2022, the interest rates for the HECM program increased from 4.81% to 5.18%. For jumbo reverse mortgages, the rates rose to 6.50%.
Along the same lines, the interest rates for proprietary reverse mortgages were higher. They rose from 4.90% to 6% in March 2022.
But interest rates can drop as well, and it depends on a range of external factors.
What are the key factors affecting your HECM amount?
Here are the factors that affect your overall HECM loan payments as well.
- Age: The older you are, the greater amount of home equity you can tap into. You must be at least 62 years old (to get a reverse mortgage at 55 years old, you will have to get a private mortgage)
- Property value: If the value of your house has increased, your loan payment will also increase.
- Financial obligations: If your mortgage, taxes, or any other dues are pending, it’ll be difficult to get approved for a HECM loan. Even if you receive approval, your loan payment might be lower than usual.
- Distribution type: You can choose to receive monthly sums, lump sum amount, line of credit, or partial sum. But if you wish to receive the best possible compensation, you should opt for a line of credit. On the other hand, the lump sum amount option gives the lowest returns.
What are the different types of HECM?
There are no sub-types of HECMs. There are only three types of reverse mortgages, as mentioned above.
Pros & cons of an HECM loan
Like everything else, HECM comes with a few pros and cons. Although these can help you navigate and get a lead for your decision, we do not recommend basing your decision solely on these.
That’s because the pros and cons we’ll list below are generic. They may or may not be useful for your specific case (depending on your financial situation). So always seek the advice of a HECM consultant before you make a decision.
What are the benefits of an HECM?
The biggest benefit of a HECM is that it helps you stay in your home and secures your retirement.
How is that so? Let’s check out a detailed breakdown of the top HECM benefits.
- Government protections
- Even when compared to proprietary reverse mortgages, a HECM has a lot more protections. This includes protections for a non-borrowing spouse, as well as for yourself. Although private mortgages come with other benefits (like borrowing reverse mortgage funds starting at age 55), they also come with a lot less protections. Be careful!
- Spend the funds on anything you like
- Other types of reverse mortgages limit your domains of expenditure. For example, if you acquire a single-purpose reverse mortgage, you’ll be bound about where you can spend the money. On the contrary, when it comes to HECM, you can spend your loan proceeds on healthcare, investments, paying off pending mortgages, going on a vacation, or anything you like.
- No monthly mortgage
- HECM liberates you from monthly mortgage expenses. You can save money to generate more funds, improve your lifestyle, or upgrade your home. However, you must pay your property taxes, home insurance, and maintenance bills regularly.
- Reliable & measured source of funds
- Financial security and safety is the best benefit brought about by HECM. In your older years — when you have more important things to think about like medical conditions and supporting your children — this reverse mortgage eases your life.
- When you sign up for HECM, you’ll get a clear estimate of the amount you’re going to receive every month. You will also receive an estimate of how long this supply of funds will last.
- Unlike traditional bank-based loans, you won’t face an abrupt or unexpected seizure of funding based on a change in banking policy or something similar. It comes from the government, which makes it highly reliable.
- Highly flexible
- When you get approved for the HECM program, you can decide whether you want a lump sum amount, monthly payments, or a line of credit. You can also opt for a combination. For example, you can settle for a small lump sum amount for home renovation and distribute the remaining reverse mortgage balance in monthly sums of money.
What are the downsides of an HECM?
The cons of HECM mentioned below may not be a con for you, depending on your case. For example, if you’ve got no heirs, you shouldn’t pay heed to leaving anything for them.
- Smaller estate left for heirs
- HECM depletes your equity in your home with time. By the time you die or move on to the next house, you may not be left with a house or monetary assets to pass on to your children.
- May affect other retirement benefits
- When you apply for HECM, the federal taxing authorities do not consider it as income, but they do see it as “reliable support.” They know you’ve got something you can count on. Hence, if you wish to avail yourself of other retirement benefit programs like Social Security Income and Medicaid, you might not be able to do so.
- It’s not entirely free
- HECM allows you to make a smart move and cut down your expenses. But not entirely — you’ll still have to spend a good amount on your home improvement, repairs, taxes, and insurance. Currently, the policies say that you’ll have to regularly pay two percent of the appraised value for insurance.
- You could lose your home
- The program lets you live in your house for the remaining of your years. But what if you’ve to leave and stay at your son’s place to look after your grandchildren? What if you have an accident and end up at a hospital or an assisted living facility for 8-12 months? In this case, your house will be vacant for more than 12 months. This, in turn, may give the lender a reason to seize it. So you could lose your home if you encounter unexpected events and fail to take timely measures.
What are the costs of a HECM loan?
The costs of HECM range from origination fees to closing costs. Here’s a quick insight into all of them:
- Loan origination fee: This is $2,500 or 2% of the first $200,000 of your property’s appraised value. If your home’s value is higher than that, the FHA will cap the fees at $6,000. You won’t have to pay any more than that.
- Reverse mortgage counseling fee: This is $125 for an hour-long consultation. This session will help you evaluate your financial situation and determine whether HECM is a good idea for you or not.
- Appraisal fees: Before you get approved, you’ll have to hire a third-party appraiser to evaluate the value of your home. You may have to pay an additional fee if the appraiser has to come for a follow-up visit after leaving suggestions on their first visit.
- Initial mortgage insurance premium: This is 2% of your house’s total value. This insurance ensures that you or your heirs do not pay more than the actual cost of your home.
- Closing costs: At the time of closing, you’ll have to pay recording fees, state mortgage taxes, title insurance, etc. The rates for these vary for each state but will remain consistent across lenders — meaning as you shop around, you will notice the closing costs are the same for each quote you receive.
Who should get an HECM?
You should get a reverse mortgage if:
- You do not have sufficient income or reliable credits to apply for cheaper types of home equity loans.
- You wish to spend the remaining of your years in your beloved home.
- You have a heavy mortgage balance, which you cannot pay further, and wish to save some money.
- You have a huge emergency expense to cater to.
- You wish to receive home health care.
- You don’t have heirs to worry about and wish to have a secure and stable retirement period.
In any case, we highly recommend seeking professional consultation before acquiring an HECM loan.
What does the AARP think of reverse mortgages?
AARP (American Association for Retired Persons) doesn’t favor or discourage reverse mortgages. The organization, however, actively advocates educating oneself before signing up for any type of reverse mortgage.
They published a useful educational resource on the subject decades ago. And recently they published a publication called Reverse Mortgage Loans: Borrowing Against Your Home to help those considering the pros and cons of a reverse mortgage.
Oftentimes, companies mislead the elderly for their benefit. To avoid this, it’s best to refer to a consultant and discuss the move with your family.
Is a HECM loan a good idea? Yes, if you are in a small group of homeowners
A HECM or reverse mortgage is a good idea if you meet the list I wrote at the top of this post. If you qualify for other home financial products (like home equity loans, HELOCs, etc) then you should definitely consider those as well. If you are confident that you don’t qualify for those products and don’t want to sell your home, then definitely speak to a mortgage advisor about whether a HECM is good or bad for your situation.