What Is a Home Equity Conversion Mortgage or HECM?

“I’ve spoken with countless homeowners who have investigated a reverse mortgage because they want to enhance their retirement income,” Auerswald says. “Many people find themselves with plenty of home equity but not enough cash flow to comfortably cover their living expenses and medical bills or simply enjoy their retirement. An HECM allows them to access that equity without having to sell their home or take on new debt.”

What are the requirements to get an HECM?

To qualify for an HECM, Auerswald shares the following criteria:

• Age: You must be 62 years or older.
• Homeownership: The home must be your primary residence
• Equity: You must have substantial equity in your home or own it outright.
• Counseling: You are required to undergo a counseling session with a HUD-approved counselor to ensure you fully understand the terms of the HECM.
• Financial assessment: You need to demonstrate that you can afford to continue paying property taxes, homeowners insurance, and maintenance costs.

“It is essential that the homeowner has either paid off the mortgage or has a low enough balance that it can be cleared with the HECM proceeds,” Auerswald explains. “The amount a homeowner can receive through an HECM is based on current interest rates and the age of the youngest borrower or eligible non-borrowing spouse, as this is tied to the borrower’s life expectancy.”

Because an HECM is a reverse mortgage insured by the Federal Housing Administration, you’ll have plenty of opportunities to ask questions before you sign a loan agreement.

“Attending the required counseling session with a HUD-approved counselor is a critical step to ensure that the homeowner fully understands the benefits and responsibilities associated with a reverse mortgage,” Auerswald says.

If you are unable to fully meet the financial requirements, a lender can set aside funds from your HECM to pay these costs on your behalf. However, this will reduce the amount of money you’ll be qualified to borrow.

How do I get an HECM?

Securing a home equity conversion mortgage involves several steps. Here’s a guide to help you navigate the process:

1. Find HUD-approved lenders: Start by using HUD’s lender list search tool to identify lenders in your area that are approved to offer HECM loans. This ensures you’re working with reputable lenders who meet federal guidelines.

2. Research and vet lenders: Once you have a list of potential lenders, take the time to research their reputations. Look for reviews, ask for recommendations, and check if they have any complaints filed with the Better Business Bureau or other consumer protection agencies.

3. Apply to more than one lender: To get the best possible terms, apply to multiple lenders. Different lenders may offer varying rates and terms, so comparing options will help you find the most favorable loan.

4. Attend a counseling session: Before finalizing your loan, you’ll need to attend a counseling session with a HUD-approved counselor. This session is designed to ensure you fully understand the terms and implications of an HECM, so you can make an informed decision.

5. Compare offers: After receiving offers from the lenders you applied to, carefully compare them. Look at the interest rates, fees, loan amounts, and any other terms that could impact your decision.

6. Select your HECM loan: Once you’ve compared all the offers, choose the HECM loan that best fits your needs. From there, you’ll work with the lender to complete the necessary paperwork and proceed with the loan.

“We’ve long been proponents of encouraging prospects to shop around and compare rates and fees,” Auerswald says. “Lenders set their own margins, and the end results can significantly affect the proceeds you receive. It’s crucial to compare offers from different lenders to ensure you’re getting the best possible deal.”

How much does an HECM cost?

The cost of an HECM includes several components:

• Origination fees: These are fees charged by the lender to process your loan. They are capped by the FHA, with a maximum of $6,000.
• Mortgage insurance premium (MIP): An upfront MIP of 2% of the appraised value of your home is required, along with an annual MIP of 0.5% of the loan balance.
• Interest rates: HECM loans can have either fixed or adjustable interest rates, which will affect the overall cost of the loan.
• Other closing costs: These may include appraisal fees, title insurance, and other standard closing costs.

Most of these costs are typically rolled into the loan balance, so you don’t pay them out of pocket. Homeowners choosing a no-monthly payment option generally come away from an HECM needing only to pay ongoing taxes, insurance, and home maintenance costs.

Can I lose my home with an HECM?

It is possible to lose your home with an HECM, but Auerswald notes that there are similar risks when taking out any loan that uses your home as collateral. “As long as you comply with the loan terms, that’s not something you need to worry about.”

With a properly maintained reverse mortgage, the benefits can easily outweigh the risks. You must continue to live in the home as your primary residence, keep up with property taxes, homeowners insurance, and necessary maintenance.

“Reverse mortgages are like any other mortgage,” Auerswald explains. “You receive a monthly statement, always knowing the outstanding balance, and you can repay the loan at any time without penalty. The main difference is that you can choose to defer the interest until the end of the loan term, whereas traditional mortgages require a set repayment schedule.”

Can I cancel or exit an HECM?

Yes, you can cancel or exit an HECM under certain conditions:

• Within the three-day right of rescission: After closing, you have three business days to cancel the loan without penalty.
• Refinance the HECM: If you qualify, you can refinance the HECM into another reverse mortgage or a traditional mortgage.
• Pay off the loan: You or your heirs can pay off the loan balance, typically by selling the home, to exit the HECM.

In short, exiting an HECM requires repaying the loan balance, including accrued interest and fees.

What homes are eligible for an HECM?

According to HUD, to be approved for an HECM, the following eligible types of homes must meet all FHA property standards and flood requirements:

• Single-family primary home
• 2-4 unit home with one unit occupied by the borrower
• HUD-approved condominium project
• Individual condominium units that meet FHA Single Unit Approved requirements
• Manufactured home that meets all FHA requirements

“There are quite a few misconceptions about reverse mortgages that I’ve come across over the years,” Auerswald says. “One big one is the fear that the bank will own your home — this simply isn’t true; you retain ownership.”

Pros and cons of an HECM loan

A home equity conversion mortgage (HECM) has both advantages and disadvantages. Here’s a quick overview:

Pros

• No monthly mortgage payments: You’re not required to make monthly payments on the loan, which can free up your cash flow during retirement.
• Access to home equity: An HECM allows you to tap into your home’s equity without having to sell your home or move.
• Flexible payment options: You can choose to receive the funds as a lump sum, monthly payments, a line of credit, or a combination of these.
• Non-recourse loan: You or your heirs will never owe more than the home’s value when the loan is repaid.
• Tax benefit: According to the IRS, reverse mortgage payments are considered loan proceeds and not income
• It’s still your home: You retain the title to your property as long as you fulfill the loan obligations.
• Maintain other benefits: Money from an HECM typically does not affect your Social Security or Medicare benefits

Cons

• Costs can add up: Fees, interest, and mortgage insurance premiums can increase the loan balance over time, reducing the amount of equity left in the home. Upfront costs tend to be higher with an HECM compared to other equity-backed loans.
• Impact on inheritance: The loan balance must be repaid when the last borrower leaves the home, which could reduce the inheritance left for your heirs.
• Potential loss of home: If you fail to meet the loan obligations, such as paying property taxes or maintaining the home, you could face foreclosure.
• Some tax considerations: The HECM interest is not tax-deductible until you actually pay off the loan.
• Interest rate fluctuations: Depending on the HECM option you choose, your loan may have a variable rate, which can increase the cost if interest rates increase.
• Risk of scams: Some scammers target seniors with HECM schemes.

While an HECM doesn’t require monthly payments, Auerswald says borrowers must understand that interest will accrue over time. This means that the loan balance will increase, which can reduce the equity left in the home.

“It’s important to think about how this might impact your estate or what you plan to leave to your heirs. I always recommend considering your future situation in the home to ensure it remains age-in-place friendly,” he advises. “For example, is the home two stories? Is there too much land to maintain long-term? If you cannot foreseeably stay in the home for your lifetime, it might be better to sell and downsize or rightsize.”

Can I use an HECM to purchase a home?

“Absolutely!” Auerswald exclaims. “One lesser-known feature of an HECM is that it can be used to purchase a new home through the HECM for Purchase program. This is a fantastic option for those who want to downsize or move to a more suitable home without taking on a new monthly mortgage payment.”

The HECM for Purchase program allows you to buy a new primary residence using a combination of a reverse mortgage and your own funds, such as proceeds from the sale of your previous home or savings.

“The process involves making a down payment and using the HECM to cover the remainder of the purchase price. I see this option as a creative solution for many homeowners looking to make a move later in life,” Auerswald says, adding, “From my experience, it’s vital to have these conversations with your family and to understand both the benefits and potential drawbacks before moving forward.”

To learn more, see our post: Buying a Home With a Reverse Mortgage (HECM for Purchase).

Downsize through a Buy Before You Sell program

If you’re downsizing, HomeLight’s Buy Before You Sell program allows you to buy a new house before selling your old one. This modern program lets you unlock equity from your current home for use toward the new purchase, covering expenses like down payments, moving costs, closing costs, and even repairs.

With your equity funds, you can make a strong offer on your new house without a home sale contingency, avoiding the hassles of moving twice. Meanwhile, HomeLight works with your agent to list and sell your old home for the best possible offer. Watch the short video below to learn more.

Alternatives to an HECM

“Deciding on a reverse mortgage should involve weighing options such as selling, downsizing, or relocating,” Auerswald suggests. “A reverse mortgage is just a tool, like many other financial products, and it’s not a perfect solution for everyone’s situation. If you have short-term needs, a lower-priced equity loan may be more suitable.”

If you’re considering an HECM but aren’t sure it’s the right fit, here are a few alternatives:

• Home equity loan or line of credit (HELOC): These options allow you to borrow against your home’s equity while retaining full ownership. However, unlike an HECM, they require monthly payments.
• Cash-out refinance: A traditional cash-out refinance replaces your existing mortgage with a new, larger loan. You receive the difference in cash. This is also an option if your home is paid off.
• Selling your home: Downsizing or moving to a less expensive area can free up equity and reduce housing costs without taking on a new loan.
• Personal loans: If you need a smaller amount of money, a personal loan might be a more straightforward option without involving your home’s equity. This alternative, along with credit cards, typically costs more and is common for homeowners seeking a short-term solution.

Auerswald points out that an HECM is different from a traditional home equity loan or HELOC in several key ways.

“Unlike a home equity loan, where you make monthly payments, an HECM doesn’t require any payments as long as you live in the home and maintain the property charges such as taxes and insurance,” he explains. “The biggest difference between an HECM and a home equity line of credit (HELOC) is suitability. A HELOC requires monthly payments and is often attached to adjustable rates. A significant concern with HELOCs is that they can be balloon notes, meaning the full balance may become due and payable [when the term ends], typically in 10 years.”

Auerswald adds a caution: “If you aren’t prepared to repay the HELOC at that time, the bank can foreclose. This cannot happen with an HECM, and the HECM line of credit is guaranteed for your lifetime.”

Is a home equity conversion mortgage right for you?

Deciding whether a home equity conversion mortgage is right for you depends on your unique financial situation and goals. An HECM can be a great option for accessing the equity in your home, especially if you’re looking to supplement your retirement income, reduce your monthly expenses, or stay in your home without the burden of a traditional mortgage payment.

However, it’s important to weigh the costs, potential impact on your inheritance, and the responsibilities that come with maintaining the loan. An HECM might be a good fit if you plan to stay in your home long-term and can comfortably manage the ongoing obligations, such as property taxes, insurance, and upkeep.

“My best advice is to take your time and really consider how an HECM fits into your broader financial plan, Auerswald shares. “I encourage everyone to talk with their trusted financial advisor, attend the counseling session, and have open discussions with family members. Making sure everyone is on the same page will help you feel confident that you’re making the right choice for your situation.”

Ultimately, the right choice is the one that provides you with the financial security and lifestyle you’re seeking in retirement.

“An HECM is a powerful tool that I’ve seen provide peace of mind to so many people, including in my own family when we completed a life-changing reverse mortgage for my grandmother,” Auerswald says.

Header Image Source: (iriana88w/ Depositpotos)