Home Equity Mortgage Overview
The Home Equity Conversion Mortgage (HECM) is an FHA insured new reverse mortgage and is the safest and most popular type of new reverse mortgage on the market. HECM’s are the only new reverse mortgage insured by the federal government through the Federal Housing Administration (FHA), a division of the Department of Housing and Urban Development (HUD).
The HECM allows home-owners, ages 62 and better, to convert part of their home equity into tax-free proceeds.* There is never a required monthly mortgage payment on a HECM, and there is no pre-payment penalty if the consumer ever chooses to pay the loan back in part or in full. Repayment of the loan can never exceed the home’s value and the heir’s will never inherit a debt, unless they choose to retain the home as their own property.
The borrower retains the home as long as loan terms are satisfied. These terms include maintaining the property and paying property taxes, homeowner’s insurance and any HOA fees. The home must be the borrower’s primary residence.
*Consult a tax specialist
Because the proceeds are a tax-free loan, there is generally no effect on Social Security or Medicare benefits. However, income-based programs may view the HECM as an additional cash flow source. Therefore, it is always best to consult an advisor when receiving benefits from an income-based program before pursuing the HECM.
The loan amount of the HECM is based on the age of the youngest borrower or eligible non-borrowing spouse living in the home, the home value, and current interest rates. Borrowers must attend HUD-certified counseling prior to applying for a HECM loan.
There are several ways to receive the funds from the HECM including:
- A single lump sum disbursement
- Equal monthly disbursements for as long as the consumer remains in the home
- Equal monthly disbursements for a set amount of time according to the consumer’s choosing
- A line of credit, in which funds are available to be drawn upon whenever the consumer chooses
- A combination of monthly disbursements and a line of credit
*Fixed rate mortgages are limited to the single lump sum disbursement option. The disbursement of mortgage proceeds during the first twelve-month period is subject to an initial disbursement limit.
Line of Credit Explained
One of the options for borrowers to receive proceeds from the HECM is a Line of Credit. Unlike a traditional HELOC, which can be reduced or closed at any time the bank chooses, the unused funds in the line of credit are guaranteed to be available to the borrower as long as they live in the home and meet loan obligations.
In addition, the HECM line of credit option has a growth rate which increases the unused amount of funds in the line automatically. This provides an easy way to tap into the borrower’s equity without having to refinance again. The most unique feature of the growth rate on the line of credit, is that it also happens to be the same rate that is accruing interest against the loan balance. As long as there are minimum funds available in the line of credit, they will grow at that rate. If the borrower wishes to pay off the HECM loan balance, then the unused portion of the line of credit will dissolve as equity.
Eliminate a Mortgage Payment
If a borrower has a current mortgage, the HECM will pay off the current mortgage debt and thus eliminate a mortgage payment entirely since no mortgage payments are required on the HECM loan. The borrower is only responsible for paying property taxes and insurance, maintaining the property and making any repairs as were required as part of the loan terms.
*The payoff of an existing non-HECM lien using HECM proceeds is only permitted if it has been in place longer than 12 months or resulted in less than $500 to the borrower, whether at closing or through cumulative draws.
The HECM product can be a great source of additional revenue for consumers and supplement monthly income. A popular disbursement choice for many consumers is the tenure payment option. This provides equal monthly disbursements to the borrower as long as they remain in the home and satisfy loan conditions. The monthly disbursements continue throughout the borrower’s lifetime regardless of home value increase or decrease. The borrower must continue to maintain the property and pay property taxes, homeowner’s insurance, and any HOA fees.
A term payment will provide equal monthly disbursements to the borrower for a set amount of time that the borrower chooses. This provides a slightly higher monthly amount but will cease at the end of the term. Of course with any payment option selected (except the lump sum option), the borrower can contact the servicer of the loan at any time to request a plan change for a small fee.
Home Equity Conversion Mortgages are insured by FHA, made possible by the payment of MIP (mortgage insurance premium) through the loan, this provides a non-recourse feature for the consumer.
Aspects of the non-recourse feature are as follows:
- The consumer will not owe more than the home is worth at the time the loan is paid back, either by death or sale of the property or failure to pay taxes
- The home is the only asset that can be used to pay the loan balance.
- This prevents the lender from using any other accounts belonging to the consumer or to the heirs (estate) to recoup the loan balance. (e.g. Even if the home was in a living trust that still has millions in available other assets in the trust, the home value is still the maximum amount that can be used to recoup the balance. Thereby leaving the other assets untouched.)
The non-recourse feature also provides benefits to the heirs of the property.
If an heir inherits the property, the heir may choose to either:
- Sell the home and the proceeds of the sale will pay back the loan with any remaining equity being given to the heir
- Refinance the home into their name and pay off the existing HECM balance
- If heirs wish to retain the property they can pay the lesser of the new reverse mortgage balance or 95% of the home’s appraised value
- Potential deferred interest deductions available to the heirs at time of sale.
Please consult your tax professional.
HECM Loan Costs
Loan costs are similar to a traditional FHA mortgage. There are 3rd party fees, mortgage insurance made payable to HUD and loan origination fees. Contact me, a licensed Retirement Funding Solutions specialist, to review your options.