Home Equity Conversion Mortgage (HECM)

What is a Home Equity Conversion Mortgage (HECM)?

A Home Equity Conversion Mortgage (HECM) is a federally insured reverse mortgage that allows senior citizens to obtain a loan based on the value of their homes.

“Home Equity” in HECM

Home equity refers to the difference between a home’s value and the amount owed on a mortgage.

For example, if the value of your home is $100,000 and you owe $40,000 on a mortgage, your home equity is $60,000. Your home equity can increase if you pay down your mortgage or if your home value appreciates.

Individuals borrow money against their home equity. Home equity is another way to measure the wealth of retirees, who often earn less income and own fewer assets. Many retirees’ net financial worth is in their homes, and they are unable to secure credit solely based on high income and a good credit score.

Often, senior citizens don’t have enough cash to make periodic payments and fulfill loan obligations. Such individuals can benefit from a Home Equity Conversion Mortgage (HECM) that grants loans based on their home values.

HECM as a Reverse Mortgage

A Home Equity Conversion Mortgage is a reverse mortgage that is federally insured by the Federal Housing Administration (FHA).

A reverse mortgage allows homeowners who are 62 years and older to borrow against their home equity. Unlike traditional mortgages, a reverse mortgage does not require homeowners to make periodic payments to repay the loan. The loan is repaid from the sale of the home.

Reverse mortgages are structured to ensure that the loan does not exceed the home value. In such a way, loan obligations can be met by selling the home after the homeowner’s death or relocation.

However, the value of one’s home can depreciate more than anticipated. In such a case, the proceeds from the home sale may not be sufficient to repay the loan. Mortgage insurance can be used to repay the remaining balance. It protects borrowers against home value depreciation. To guarantee the insurance coverage, borrowers must pay mortgage insurance premiums to the FHA.

If the proceeds from selling the home are greater than the loan balance, then surplus amounts can go to the borrower’s heirs (if the borrower is dead) or the borrower.

Sometimes, children of deceased parents can pay off the HECM and keep the home if they see emotional value in looking after their parents’ homes.

Eligibility and Approval Process

A Home Equity Conversion Mortgage is the most popular reverse mortgage as it doesn’t come with strict income or medical screening requirements. A person is eligible for a HECM if:

• She/he is 62 years or older
• Owns the home or has paid a significant portion of the purchase price
• Lives in the home (primary residence)
• Does not have delinquency on federal debt
• Can participate in an information session given by a HECM counselor
• Can pay mortgage insurance premiums (must be paid to cover FHA losses if home value depreciates), property taxes, homeowner association fees, servicing, origination, and loan closing fees.

In addition, homes must:

• Meet all FHA requirements
• Be single-family units or a 2–4-unit home where the applicant lives in one of the units

Individuals must complete a HECM application to be eligible. Before applying for a HECM, homeowners meet with a counselor for information on cost, payout, risk, and alternative credit solutions.

Applications are reviewed based on age, interest rates, and home value to determine the loan amount. The youngest borrower’s age is considered if there are multiple borrowers. Generally, older ages, high equity values, and low interest rates lead to higher loan amounts.

HECM Amount and Payout Options

The maximum loan amount that can be granted is the lower of the home’s appraised value or the mortgage limit. Received amounts are tax-free.

A HECM is granted using the following payout options:

1. Lump sum – Funds are granted as a single disbursement when the loan is agreed upon
2. Line of credit – A specified amount of money that can be drawn when needed and repaid immediately or over a period of time
3. Tenure payment – The homeowner receives fixed monthly payouts if he/she lives in the primary residence. The amount received is not lowered even if the home value declines
4. Term payment – The homeowner can choose to receive fixed monthly payouts for a predetermined term, e.g., seven years. The amount received is not lowered even if the home value declines.
5. Modified tenure payment – The homeowner receives fixed monthly payouts if he/she resides in the primary residence. Monthly payouts are supplemented with a line of credit that can be drawn on if more funds are needed.
6. Modified term payment – The homeowner receives fixed monthly payouts for a specific term, which can be supplemented by drawing on a line of credit.

Advantages of HECM

• Borrowers maintain ownership of their homes
• Tax-free funds
• No monthly loan repayments
• Leniency on credit score, medical, and income requirements
• Retirees can access funds based on their home equity
• Homeowners can obtain funds in their preferred way through a line of credit, modified tenure, etc. based on their preferences
• Homeowners never pay back more than their home values (mortgage insurance covers the balance)

Disadvantages of HECM

• The loan matures if the borrower dies, and people living with the borrower must vacate
• The loan matures if the borrower relocates
• The loan will be called if the borrower can’t pay property taxes, mortgage insurance premiums, maintenance costs, or other fees

Additional Resources

Thank you for reading CFI’s guide to Home Equity Conversion Mortgage. To keep advancing your career, the additional CFI resources below will be useful:

• Creditworthiness
• Home Equity Line of Credit (HELOC)
• HELOC Calculator
• Subprime Mortgage
• See all commercial lending resources
• See all commercial real estate resources