How Does A Hecm Loan Work

HECMS are nonrecourse, so the borrower is not required to pay more than the value of the home at the end of the loan. (Getty s).

You’re not the only one who doesn’t understand what a reverse mortgage is or what it does. Simply put, with a reverse mortgage, the lender pays you instead of receiving a monthly mortgage payment from you. When you sell your home, you repay the loan. Older homeowners can access the equity in their homes with a reverse mortgage while they are still alive. Although this seems like a fantastic deal, there are still risks.

While homeowners will value the additional funds a reverse mortgage can provide in retirement, the withdrawals and compound interest will deplete the value of their hard-earned homes. Additionally, consumers should be aware of reverse mortgage sales pitches to ensure the financial arrangement is in their long-term interests.

One type of reverse mortgage, known as a home equity conversion mortgage, is supported by the Federal Housing Administration. If your loan debt is greater than the value of your home when you move out, FHA backing ensures that neither you nor your family will be stuck with a hefty bill. As a result, HECMs are the most widely used kind of reverse mortgage.

Learn more about HECMs, how they differ from other types of reverse mortgages, how to become eligible for one, and whether or not they might be the right choice for you.

What Is a Reverse Mortgage?

Reverse mortgages enable older homeowners with equity in their homes to convert that equity into cash. A reverse mortgage, as opposed to a regular mortgage, which you pay off each month to accumulate equity, enables you to access the equity while still owning the property without giving up the title.

If you have a traditional mortgage, you can use your reverse mortgage to pay off the remaining balance and then take a lump sum or regular payments from your equity to cover expenses. When the last surviving homeowner sells the house, passes away, or moves into a new principal residence, the loan is paid back.

Wade D. advises, “If you take that big expense out of your budget, you can really improve your cash flow situation and don’t have to deplete your investments as much.” Pfau, co-director of the American College Center for Retirement Income.

What Types of Reverse Mortgages Are There?

There are three types of reverse mortgages:

HECM. The vast majority of reverse mortgages are HECMs. Only homeowners 62 and older are eligible for HECM loans, and there are significant closing-day and ongoing insurance costs. The advantage of HECM loans is that they are nonrecourse, meaning that the homeowner or the homeowner’s estate (in the event of a death) won’t be required to pay more at the conclusion of the loan than the home is worth, regardless of whether the home’s value at the time of sale is less than the loan balance.

According to Shelley Giordano, founder of the Academy for Home Equity and Financial Planning at the University of Illinois, “that gap is covered by the FHA insurance,” for instance, if your reverse mortgage loan reaches $325,000 but the appraised value of your home is only $300,000 “On a reverse mortgage, there are never any payments required beyond what the house provides.” “.

Additionally, your home is the only asset the lender can seize if you default on an HECM, such as by failing to pay property taxes, and the FHA contributes to the lender’s costs.

An HECM loan offers a number of payment options, including a lump sum withdrawal, regular cash advances, and a line of credit.

Additionally, the size of HECM loans is limited; for 2022, the maximum FHA claim amount is $970,800. Another choice is accessible to homeowners who want to obtain a larger reverse mortgage.

Proprietary. Although there are fewer restrictions with this type of reverse mortgage, the FHA does not guarantee it. The minimum age is lower, usually starting at 55, and the maximum loan amount is much higher.

Options for payment include a line of credit, term payments, and lump sums.

Single purpose. These loans, which are intended for low- to moderate-income homeowners and restricted to costs like home repairs, improvements, or property taxes, are provided by some local, state, and nonprofit organizations.

How Do You Qualify for an HECM?

As long as you are at least 62 years old and can meet the federal government’s and the lender’s requirements, which include passing a financial assessment

As an HECM applicant, you will need to:

Have a large amount of equity in your home or own it outright. At least 50% equity would be ideal, Giordano says.

Attend financial counseling sessions with an FHA-approved HECM counselor.

Designate the property your principal residence.

Owe no debt to the federal government.

As part of a thorough financial analysis created by the FHA, lenders will review your credit history, assets, and expenses. The value of the house, your ability to pay for homeowners insurance and property taxes, the current interest rate, and longevity projections based on the borrowers’ ages are some of the variables, according to Giordano. According to Giordano, the financial analysis informs the lender of the amount you are qualified to borrow. Lenders will use formulas based on longevity tables and interest rates if you want to spread out the payments or credit line over a number of years.

The FHA is particularly concerned with preventing people from taking out reverse mortgages unless doing so is a viable option for them, she continues.

Maintaining your home to maintain its fair market value is another essential aspect of having an HECM loan. In order for your lender to be able to recoup its loan, it wants you to be able to sell your house for a profit.

What Are the Best HECM Options?

Your financial situation and retirement strategy will determine the best HECM option.

According to Pfau, you should position your assets for the best retirement outcome. “While your house is a valuable asset, it’s not the only one,” Avoid taking out a reverse mortgage before planning your retirement without considering the big picture. “.

The lender will determine the initial principal limit at closing, which is the maximum amount you can receive from the HECM.

Uses for an HECM, which has a fixed or variable rate, include:

Traditional use. If youre obtaining an HECM for your principal residence.

Refinancing. If youre refinancing from another HECM loan.

Home purchase. If you use the HECM loan to buy a new primary residence.

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Popular ways to use an HECM include the home purchase option, which debuted in 2009, and the refinance option. Due to rising home values and low interest rates, refinancing has become more appealing in recent years.

A HECM for home purchases enables homeowners to purchase a new primary residence without obtaining a conventional mortgage. For instance, if you own your home outright, you could use the sale proceeds to put a down payment on a home that is more expensive and use a reverse mortgage to pay the balance.

There is only one payout option available to you if you choose a fixed-rate HECM. Adjustable-rate HECMs offer a variety of options:

Single disbursement. If you get a fixed-rate HECM, this lump-sum distribution is your only option. It might provide you with less money than other types of HECM loans.

Tenure. You can receive equal monthly cash advances as long as one of the borrowers lives in the home as a primary residence.

Term. This provides for equal monthly cash advances for a fixed amount of time.

Line of credit. You can have cash available at a time of need, at any amount you choose, until the line is used up. You would only pay interest on the credit you use.

Combinations. You can also combine the term or tenure options with a line of credit.

What Does an HECM Cost?

If you take out an HECM, you’ll probably pay thousands, if not tens of thousands, in closing costs and insurance costs. Heres how the costs break down:

Mortgage insurance premium. At closing, you will pay a mortgage insurance premium of 2% on the maximum claim amount. Youll also be charged an annual premium that equals 0.5% of the remaining balance of the mortgage. These charges help cover the federal governments commitment to insure the loans. The initial premium can be financed within the loan, although that will limit the amount of equity that gets paid to you.

Closing costs. Youre also likely to pay all or most of the typical processing and closing fees, such as for the appraisal, title search and recording fees.

Origination fee. The minimum origination fee is $2,500. A lender can charge 2% of the first $200,000 of your homes value plus 1% of the amount over $200,000. HECM origination fees are capped at $6,000.

Servicing fee. Lenders can charge an ongoing servicing fee capped at $30 or $35, depending on how often the interest rate adjusts.

You can search for the best interest rate and fee package if you pursue HECM offers from several lenders. You can choose to have a higher interest rate in exchange for lower closing costs, just like with a regular mortgage, says Giordano. [.

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When Is an HECM a Good Idea?

Youre staying in your home. You can spread the closing fees over a longer period of time and also rely on the payments from the HECM to pay for ongoing and/or emergency expenses. An HECM could also help you pay for renovations to retrofit your home for aging in place.

You want to preserve your estate. If you have other nonhome assets – such as an investment portfolio – funds from an HECM can cover everyday costs while the investments remain untouched and can grow. “If they’re using it responsibly, a reverse mortgage can serve to extend the longevity of their assets,” Pfau says.

Youre planning for the future. Dont look at the HECM as a last resort – it can be a ready source of credit that you take out at 62 and dont use until you really need it years later. Unlike some other funding sources, such as a home equity line of credit, an HECM will always be there. “If housing values drop, you still have access to that line of credit, which makes it completely different than a HELOC,” Giordano says.

When Is an HECM Not a Good Idea?

Youre moving soon. The upfront costs of an HECM are considerable, and dropping the loan after a year or two isnt a wise financial move.

You cant manage money. “People who struggle controlling their spending might be better off not tapping into their home equity,” Pfau says. Interest on the HECM will compound over time, which can cut into your equity and limit your ability to use those funds for expenses in years to come.

You havent planned effectively. Speak with your family – your spouse, children and others – to consider whether your short-term and long-term plans are sound. For example, if you take out an HECM, it will decrease the amount of available equity in your home, which could make it more difficult to afford costs at an assisted living facility in years to come, since financing such a move often depends on the value of your assets and income.

An HECM can help you pay for long-term expenses, both anticipated and unforeseen, and is a major life decision that will impact both your retirement and the value of your estate. A reverse mortgage is ideal for anyone who understands they don’t know what the future holds and wants to be in a position to protect their nest egg, according to Giordano.

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FAQ

What is the downside of an HECM loan?

Cons of HECM: You must reside in your property for a significant portion of the year in order to receive a HECM. If you decide to sell your house or move, you will be required to repay the HECM.

What is the difference between a HECM mortgage and a reverse mortgage?

The only reverse mortgage insured by the U. S. A Home Equity Conversion Mortgage (HECM), which is only available through FHA-approved lenders, is known as a Federal Government. The HECM reverse mortgage program from the FHA enables you to take out a portion of the equity in your home.

Is HECM for purchase a good idea?

Due to credit issues or insufficient income, homeowners who are unable to obtain home equity loans at lower interest rates may benefit from HECM reverse mortgages. Borrowers with bad credit don’t pay higher interest rates than those with good credit, which is one benefit of an HECM reverse mortgage.

How is a HECM repaid?

When you pass away or sell your house, a home equity conversion mortgage, or HECM, also referred to as a reverse mortgage, must be fully repaid. When the house is sold, the lender recoups the money advanced to you, plus interest.