A home equity conversion mortgage (HECM) is a type of reverse mortgage. The Federal Housing Administration (FHA) insures the mortgage, which helps seniors cash out their home equity. This can be a nice perk if taxes on the property, insurance or other living expenses have increased and you’re looking for a way to make ends meet. Learn more about how the loan process works and when you might use a HECM.
Understanding Home Equity Conversion Mortgages
Homeowners must be 62 years old to use this reverse mortgage tool. The HECM first pays off any existing mortgage you have on the home, making it so that you have no monthly payments for principal and interest. You will still be responsible for paying taxes and insurance costs.
One unique aspect of the loan is that you won’t have to repay it until you sell the home, die or move out of the property. However, the loan still accrues interest. That interest gets added to the total loan balance each month. Borrowers can still make monthly payments on the loan though without any penalties.
Heirs can purchase the home from the homeowner and pay off the loan for the lesser of the full amount or 95% of the home’s appraised value. Alternatively, the homeowner’s heirs can sign over the home to the lender if they do not wish to purchase the home or cannot sell it for more than the loan’s value.
How Does an HECM Work?
An HECM works a great deal like other types of reverse mortgages, but it often has a lower interest rate. The interest rate you get will depend on your age and how long you anticipate living in and owning the home.
To gain a clearer understanding of how this type of loan works, here’s an example.
A couple in their early 70s owns a home valued at $500,000. They owe $20,000 on it. Depending on their lender and terms, they might be eligible for an HECM that pays out 40% to 75% of the home’s equity. The home’s equity is $480,000, meaning they could get between $192,000 and $360,000.
The total value of the loan will depend on the life expectancy of the couple as well as the borrowers’ credit score.
Once the borrowers close on the loan, they’ll receive monthly payments for the specified amount of time they agreed to in the loan terms.
HECM vs. Other Types of Reverse Mortgages
As you compare loan options, you’ll find HECMs differ from other reverse mortgage options. First, you must be at least 62 years old for an HECM, while other reverse mortgages are available to people who are 55 and older.
You’ll also have more options for how you receive your funds and for how long you take payments with an HECM. Other reverse mortgage tools are paid in a lump sum only.
How you can use the funds also differs because most reverse mortgages require you to use them to pay off debt or make home improvements.
HECM vs. Home Equity Loan
HECMs and home equity loans work differently. First, the eligibility differs because you’ll need to be 62 to qualify for an HECM while a home equity line of credit has no age requirement. You also can take monthly disbursements from an HECM while a home equity line of credit is paid in a single lump sum. To qualify for an HECM, you’ll need to own the majority of your home. But to get a home equity loan you only need 20% equity in your home.
Repayment terms also differ greatly. For an HECM, you’ll need to pay the balance with interest when you move, sell the home or die. But a home equity loan is due in regular installments of principal and interest payments.
Pros and Cons
Before pulling the cash out of your home, review the pros and cons you can expect. Here’s a look at its benefits:
- Pay off your existing mortgage to reduce monthly expenses
- Build up funds for other expenses, such as medical emergencies
- Provide your heirs the option to buy the home or release it to the bank without paying off the loan amount thanks to the loan’s federal insurance
- Remain in your home where you are comfortable while maintaining a steady income
- The benefit is tax-free, meaning for most borrowers it only has upside
- If one spouse dies, the other continues to benefit from the loan to live in their home without mortgage payments
While there are many reasons to consider an HECM, here are a few reasons you might avoid this arrangement:
- Higher fees and interest rates compared to traditional mortgages
- If you’re out of your home for the majority of the year, such as to enter a nursing home or rehab center, your loan could become due
- Although your heirs don’t have to pay off the loan, they’ll be left to deal with the loan upon your death
- You could outlive the proceeds of the loan depending on the payment plan you select
Who Is Eligible for a Home Equity Conversion Mortgage?
Not everyone will qualify for a home equity conversion mortgage. Review these qualification requirements the Federal Housing Administration sets.
- Must be at least 62 years of age
- Must own the property completely or have a small mortgage balance
- Must use the property as primary residence
- Can’t be delinquent on any federal debt
- Must complete a consumer information session with an approved HECM counselor
- Must be a single-family home or a one- to four-unit property that you occupy
- If it is a condominium, it must be a project approved by the U.S. Department of Housing and Urban Development (HUD)
- Manufactured homes must meet FHA requirements
Check whether you’re eligible for the benefit by completing a simple survey through HUD.
How to Get an HECM
Getting started with an HECM involves several steps. Here’s what you can expect:
- Initiate the application. This will include some basic information, including your date of birth, address and remaining mortgage.
- Talk with the loan officer to learn your options and what you’re eligible for.
- Complete HECM counseling from a third party that is HUD-approved. You’ll need to pay expenses for the counseling out of pocket. Once you’ve completed the counseling, it is good for six months. You can often complete the counseling over the phone.
- Provide supporting documentation to a notary who will validate the documents. You should be ready with the following: HUD counseling certificate, photo ID, proof of birthdate, Social Security card, property deed, your latest real estate tax bill, the declaration page for your homeowners insurance, statements for your mortgage, home equity line of credit statement (if applicable), income documentation and credit report authorization.
- Complete a property appraisal, which will provide a clearer view of the loan size. An FHA appraiser must complete this process for it to be valid for a HECM.
- Your loan will then go to underwriting where they will check for liens, review your credit history and check for issues. You might need to provide further documentation at this phase of the process.
- Receive closing clearance, at which time you’ll schedule a notary to visit your home to sign closing documents.
- The loan is funded and you’ll receive the funds four days after you sign the closing documents.
Compare the Best Reverse Mortgage Offers from Benzinga’s Top Home Loan Companies
Find leading home loan companies that provide HECMs to compare rates and find a lender that best meets your needs.
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Available in: CA, CO, CT, DC, FL, GA, IL, MD, MA, MI, NH, NJ, NY, NC, OH, PA, RI, SC, TN, TX, VA, WA
Cash Out the Equity in Your Home Without Payments to Live More Comfortably
Enjoy regular payouts from your home using an HECM so you can live more comfortably during retirement while staying in your home. You can use the equity from your home to pay monthly expenses or to cover property taxes or homeowners insurance premiums to make your home more affordable. See whether you qualify for a home loan that doesn’t require monthly payments or repayment until you die or sell your home.
Frequently Asked Questions
What is the difference between an HECM and a reverse mortgage?
How you use the funds from an HECM is far more flexible than a traditional reverse mortgage. You can finance retirement expenses with an HECM, while you can only pay off debts or complete home repairs with a reverse mortgage.
How much home equity is needed for a home equity conversion mortgage?
The qualifications for a home equity conversion mortgage vary based on the lender. Most lenders require that you have 40% to 75% equity in your home.
Is interest on a home equity conversion mortgage deductible?
The interest on a home equity conversion mortgage is only deductible if you pay it off. As long as you allow the interest to accumulate on the loan, you won’t get any tax benefits from it.
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About Rebekah Brately
Rebekah Brately is an investment writer passionate about helping people learn more about how to grow their wealth. She has more than 12 years of writing experience, focused on technology, travel, family and finance. Her work has been published in Benzinga, Hearst Bay Area, FreightWaves and Dallas Observer publications.