What is a HECM and How Does it Work?
As a reliable supplementary income source for retirees, HECMs flood the market as a frequent choice for borrowers, yet few know how these types of reverse mortgages work. Discover how a HECM works along with its regulations to determine if the loan suits your financial plans.
A Home Equity Conversion Mortgage (HECM) is a reverse mortgage insured by the U.S. government’s Federal Housing Administration (FHA) that allows retirees to convert their home’s value into money. The loan provides users funds for the exact market appraisal of their home and, as a nonrecourse loan, only demands applicants repay this same value once due. Once any pre-existing mortgages are paid off, HECM applicants are free to use the loan funds as they please as long as FHA compliance is met, either by affording a more comfortable retirement lifestyle or growing their savings.
In fact, should applicants feel financially stable, HECM loans allow prepayments to the account prior to the set deadlines without penalty or increased interest. As such, borrowers can effectively live comfortably and securely with little financial debt by paying HECM interest and fees back at a steady rate.
Basics to a HECM
HECMs are a popular type of reverse mortgage. Being the only government-insured type of reverse mortgage available, they are a popular kind of reverse mortgage, and frequently offered by advisors due to their high reliability and security protections for borrowers. That said, HECM loans do come with certain limitations regarding fees, eligibility, and payment. Below is a summary of requirements borrowers must meet to use a HECM loan:
Payment Options and Requirements
Although HECM loans have interest built on their balance, repaying the loan isn’t needed until homeowners either move, sell, or pass from the property. If the home sells under the established home equity, the FHA pays the difference, leaving the borrowers free from additional expenses. In the event borrowers pass before repaying their HECM, all payment responsibilities fall to their heirs, whereupon they may either buy the home at 95-100% of the home’s value—whichever is less—or sell the property.
Excluding monthly payments, HECM applicants must pay certain closing, servicing, and premium insurance fees. While these payments can be complied into the outstanding balance, the extra charges create a net principal limit, lowering the total home equity borrowers can access. To balance these fees, HECMs typically offer lower interest rates, which during unstable economic periods can help relieve borrowers of extra charges.
As far as receiving funds, borrowers have two options: fixed-rate or adjustable-rate HECMs. Fixed-rate HECMs have a set interest rate throughout the loan’s duration and only offer lump sum payments. On the other hand, adjustable-rate HECM interest rates can change during the loan’s use, with more payment options such as a lump sum, monthly payment, credit line, or even combinations of the three methods.
Since the FHA sponsors the HECM loan and insurance, borrowers looking to apply for the loan must adhere to the association’s strict guidelines to be eligible for approval. HECM eligibility under FHA guidelines can only be approved if the applicant:
- Applies and obtains their HECM from an FHA-sponsored bank
- Is 62 years of age or older
- Currently owns or paid a significant down payment toward a primary residence
- Will use their property as the main residence
- Occupies either a single-family, 2-4 unit, or manufactured home and/or condominium approved by the FHA or U.S. Department of Housing and Urban Development
- Does not have outstanding or federal debt disparities
- Upholds all property responsibilities such as property taxes, homeowners insurance, and maintenance repairs on time
Individuals eligible for a HECM loan must be 62 years or older, use their primary residence, and able to pay all home costs.
Due to the complexity and security involved with a government-insured reverse mortgage, borrowers looking to use a HECM must complete a HUD-sponsored counseling session. During this discussion, HUD third-party advisors instruct how the HECM works, all policies, and the financial commitments involved with the loan.
Regardless of whether an applicant meets all other requirements, lenders can still deny a HECM request if the individual’s finances are deemed insufficient. To decide if an applicant can meet HECM requirements, HUD enforces a financial inspection of all borrowers. Tax history, debts, and current income are examined to see if a reverse mortgage is sustainable by the borrower’s financial state.
HECM loans have so many regulations and requirements to not only ensure borrowers can be trusted, but also that home equity funds are consistently repaid. While HECMs do allow individuals to access their home equity funds, though, the FHA restricts how much can be borrowed. Considering the effect of inflation and recession rates on the housing market, if homeowners receive a loan over $1 million in home equity funds, for example, these same economic factors could make repaying the loan later on nearly impossible. Thus, HECM borrowing limits are factored by the minimum age eligibility, interest rates, and total home equity. Despite HECMs having a maximum loan limit, starting January 1, 2023, HECM applicants will be able to claim up to $1,089,300, thereby allowing applicants more access to funds and savings in the new year.
File Your HECM with PCL Financial Group
Compared to other reverse mortgage options, HECM loans offer a greater degree of stability, security, and dependability of funds when looking to save for retirement. In spite of the regulations required for the application, our advisors at PCL Financial Group foresee great opportunities for borrowers to receive more support and home equity funds within 2023. To learn more about our options, consult with one of our advisors!