If you’d like to pay off your mortgage to gain full ownership of your home, you could do so with the use of a home equity conversion mortgage (HECM). For half a century, reverse mortgages have provided seniors with the ability to reach the financial goals they set during retirement. Over the years, reverse mortgages have been refined and updated to ensure that seniors have several options available to them.
Today, there are several types of reverse mortgages that you could apply for, the primary of which is a home equity conversion mortgage. This mortgage gives homeowners certain protections while also providing them with a flexible method in which to use their funds.
Even though a HECM loan can be highly advantageous, there are some downsides to this option that everyone should be aware of before applying for the loan. The following guide goes into detail about HECM mortgages and when they should be used.
Understanding Home Equity Conversion Mortgages
A home equity conversion mortgage is a type of reverse mortgage loan that’s insured directly by the Federal Housing Administration for borrowers who are 62 years old or above. Homeowners are able to use this government-insured loan to convert any existing home equity they’ve built up into cash. Keep in mind that not every lender offers HECM loans.
If you’re approved for this type of loan, it can be used to pay off your existing mortgage if you still have one. Any remaining money from the loan can then be used for practically anything since you won’t be tasked with making monthly mortgage payments. Keep in mind, however, that you’ll still need to pay for homeowners insurance and property taxes while you continue living in the home.
If you don’t make a loan payment each month, interest from that specific month will be added to the total loan balance. Monthly payments with a HECM loan are optional. However, you can choose to make monthly payments as a result of these loans not having a prepayment penalty. Your monthly payments will initially go towards the interest that you owe before covering the loan principal as well as any fees.
Once you decide to sell your home, you will need to pay off the entirety of the HECM loan with your proceeds. The same is true if the borrower passes away. Heirs are able to sell this property or buy the home for the total amount due. It’s also possible to sign over the home deed to the lender, which allows the beneficiary to walk away from owning the home.
How Is a HECM Different from Other Reverse Mortgages?
There are several ways that HECM loans differ from other types of reverse mortgages. There are three distinct types of reverse mortgages you can apply for, which include HECM loans, proprietary reverse mortgages, and single-purpose reverse mortgages. The HECM loan is the only reverse mortgage that’s insured by the government. It’s also the least risky option available to homeowners because of the governmental protections that borrowers gain access to.
HECM loans are considered to be non-recourse loans, which are loans that don’t allow the borrower to owe more than their property is worth. In the event that your home sells for less than what you currently owe, the Federal Housing Administration will cover the difference. You’ll also discover that there isn’t a credit impact attributed to the borrower or any of their heirs if they decide to give the house to the lender.
How Is a HECM Different from a Home Equity Loan?
HECMs are also different from home equity loans. A home equity loan is designed to provide homeowners with cash based on the amount of equity they’ve built up in their home. When using a HECM reverse mortgages, your monthly payments will be optional unless you don’t meet specific requirements. The same isn’t true with a home equity loan.
These two types of loans also differ in how the proceeds from the loan can be received. HECMs provides homeowners with more options on how to obtain their proceeds. When you’re approved for a home equity loan, funds will only be disbursed via a single lump sum payment. In comparison, HECM loans offer you the ability to receive the funds as a line of credit, in monthly installments, or as a lump sum payment. Keep in mind that eligibility requirements also differ.
How Do You Get a HECM?
If you want to apply for a HECM, you can only do so with a lender that’s been approved by the U.S. Department of Housing. The loan application process can be completed in several steps, which include:
- Required HECM counseling
- Approval amount
- Financial assessment
- Consider payment options
Required HECM Counseling
The first step in this process involves obtaining HECM counseling. Because of how unique this type of reverse mortgage is, the HUD requires borrowers to take and complete a standard reverse mortgage counseling session.
This session is approved by the HUD and will teach you what the loan entails, the costs associated with the loan, and additional finance options that are available to you. Counseling can cost upwards of $200 and will last as long as 90 minutes. It’s possible for counseling to occur in person or over the phone.
The three factors that dictate the amount of money you can borrow with a HECM include:
- The youngest borrower’s current age
- Current interest rates
- The total amount of equity you’ve built up in your home.
The next step in this process involves performing a financial assessment. During this stage, lenders make sure that borrowers have a strong enough financial position to take on the obligations that come with the loan, which include paying for home maintenance costs, homeowners insurance, and property taxes.
Borrowers must also go through a financial assessment, which involves the lender reviewing your debts, income, and credit history. Keep in mind that your credit score won’t be taken into account. Your lender may choose to set some of your proceeds aside to pay for homeowners insurance and property taxes depending on your financial situation.
Consider Payment Options
Since you have the ability to choose how you will be paid, the final step in this process involves considering your payment options, of which there are three available to you. There are two basic types of HECM loans you can apply for, which include a fixed-rate loan and an adjustable-rate loan.
If you choose the fixed-rate loan, your interest rate will remain the same until you’ve repaid the loan. However, you can only receive your payments in a lump sum. As for the adjustable-rate option, it comes with a fluctuating interest rate. With this type of HECM, you can receive your payment as a lump sum, line of credit, monthly payments, or a combo of the three.
Lump sum payments allow you to receive the entirety of the loan at once. In comparison, the monthly payment option allows you to obtain proceeds in the form of monthly payments for a specific period of time.
The line of credit mentioned previously allows you to access your credit whenever you require the money. In the event that you don’t withdraw all of your proceeds immediately, your funds will increase over time, which gives you more money in the long run. Keep in mind that lines of credit can’t be suspended while you have this loan.
You can also choose to obtain a customized payment solution that combines different payment options. For instance, you could obtain a line of credit that pays out in monthly payments.
What are the Eligibility Requirements For a HECM?
If you want to be approved for a HECM, the requirements you must meet include:
- You need to be at least 62 years old
- Your property needs to be your main residence
- You need to have a substantial amount of equity in your home
What are the Pros and Cons of a HECM?
Even though these types of mortgages can be highly beneficial, they aren’t for everyone. These are complex loans, which is why every facet of the loan should be considered before you apply for one.
Pros of a HECM
The main benefits of a HECM loan include:
- Your proceeds can be used to supplement your current income, pay off your debts, or for practically anything else
- Your monthly mortgage payments can be eliminated
- You will continue to own the home
- Your credit score isn’t taken into consideration
- Because this loan is insured directly by the FHA, you’re protected from reduced home values
Cons of a HECM
The main issues with HECM loans include:
- These loans come with relatively high fees
- In the event that a medical emergency keeps you in the hospital for a large portion of the year, you may need to repay this loan immediately
- You could outlive the proceeds you receive if you select a monthly payment plan
Should You Get a HECM?
This type of loan provides seniors with the opportunity to use the equity they’ve built up in their home to pay off their current mortgage and have money left over. Since the loan is insured by the government, you’re given certain protections that aren’t available with other types of loans.
If you would like to supplement your retirement income or pay for a vacation, a HECM loan may be a great option for you since your current mortgage will be paid off completely. While HECM loans are beneficial, it’s highly recommended that you consider all of your options, which include other reverse mortgages and home equity loans.