Home Equity Conversion Mortgage (HECM)
Such an instrument serves to create an income source that can help in the retirement of individuals.
A home equity conversion mortgage (HECM) or a Home Equity Loan is a federally issued reverse mortgage allowing a select group of homeowners to receive a monthly payment against the equity on their home.
Home equity loans were introduced for homeowners aged 62 and older to use their home equity as an instrument to generate cash flows throughout retirement.
Therefore, a home equity loan is categorized as a reverse mortgage, allowing the homeowner to convert their equity into cash through a regular series of cash flows over a predetermined period.
Hence, such an instrument creates an income source that can help individuals' retirement. Thus, the requirement for the homeowner to be aged 62 or over is put into place to cater this instrument to a specified group of people.
The Federal Housing Administration (FHA) insures home equity loans. This means that the loan payments are guaranteed or insured by the federal government in case of default on the part of the bank.
A Home Equity Conversion Mortgage and a Reverse Mortgage have much in common. All home equity loans are classified under reverse mortgages as they are an instrument that allows an owner of an asset to convert their equity for regular payments.
The first reverse mortgage was approved in 1961 when a supposedly small bank in Portland, Maine, had come up with a creative solution to help a woman keep her home while staying at home after her husband's sudden death.
Such an idea picked traction, so the Federal Housing Administration (FDA) proposed to launch several types of reverse mortgages in the U.S. This proposal gained political approval and support in the 1980s. Thus, the first home equity loan was then introduced in 1989.
By 1994, the government pushed reverse mortgage lenders to make costs transparent to customers. Further, the government made this type of reverse mortgage permanent through the HUD Appropriations Act.
At this time, Fannie Mae tried to introduce its reverse mortgage called the "Home Keeper," which has since been discontinued. A change also allowed borrowers with four units to be eligible for a reverse mortgage as long as one of the units was their primary residence.
In the 2000s, The United States Department of Housing and Urban Development (HUD) increased reverse mortgage origination fees, a critical source of revenue for lenders to attract more firms to offer such instruments.
Further, there was also a partnership between the HUD and the American Association of Retired Persons (AARP) to improve counseling services for home equity borrowers after information that borrowers were struggling to pay property owning costs such as taxes and insurance.
By this time, the home equity market was doing well and helping cash-strapped homeowners in their retirement. Therefore, those that didn't qualify for the selective home equity loan lending criteria could access other new instruments such as jumbo reverse mortgages.
After the Great Recession, origination fees were at all-time lows, which impacted the reverse mortgage space. However, the most common home equity loans were still in demand, subject to much tighter legislation.
In 2010, the home equity loan saver was introduced, which allowed seniors to put up lower equity of their homes as collateral for the loan. This idea offered lower overall fees. However, it did not work as expected; hence it was discontinued by 2013.
In 2013, the Reverse Mortgage Stabilization Act was introduced, which made a few changes to the reverse mortgage space in terms of regulation and limits.
Today, home equity loans continue to be in demand. However, rapid inflation has increased the national loan limit from $822,375 to $970,800.
It will continue to be interesting to observe how home equity loans evolve and what type of new instruments are introduced in the next decade that help homeowners in their retirement.
Examples of HECM loan companies
- American Advisors Group (AAG) is one of the world's largest reverse mortgage firms in the U.S.
- Liberty Reverse Mortgage offers mortgages at excellent costs for outstanding credit-worthy borrowers.
- Longbridge Financial is a firm originally founded in 2012 that specializes in reverse mortgages.
- Finance of America Reverse has a user-friendly online platform that helps users to work with the lender.
- Reverse Mortgage Funding usually has far more equity access and thus is easier to qualify for. In addition, the company offers lump-sum payments, line of credit payouts, monthly reimbursements, and combination payouts.
- Finance of America Reverse (FAR) offers competitive fixed interest rates while also offering large loans amounting to $4 million.
A home equity loan can be structured differently based on the loan's purpose for the individual applying. Therefore, payments and other aspects of the debt may be constricted distinctively.
Some characteristics of a home equity loan can be altered to meet the homeowner's goals. For instance, consider some of the following ways in which the proceeds of the home equity loan may be distributed:
- Lump sum payment
The homeowner can choose to receive all the proceeds as a lump sum at the end of the loan period. However, this option is only available at a fixed interest rate.
- Equal monthly payments (annuity)
This type of debt is structured so that the borrower receives periodic monthly payments as long as the borrower holds the property as a principal residence. This is known as a tenure plan.
- Term payments schedule
The borrower can decide to receive payments based on a term, for example, ten years. Then the lender can equally spread out the fees to pay until the end of the word.
- Line of credit (LOC)
A home equity loan can be structured so the borrower has an available line of credit if needed. In addition, the homeowner can negotiate to only pay interest on the amounts borrowed from the credit line, thus keeping other payments interest-free.
- Equal monthly payments plus a usable line of credit
The lender provides consistent monthly payments for as long as at least one borrower occupies the home.|
Further, If the borrower needs more capital at any point, they can access the line of credit previously negotiated as part of the home equity loan.
- Term payments plus a usable line of credit
This type of home equity debt structure is a payment plan where the borrower chooses the term they wish to receive payments for, and thus the costs are equally spread out for that term. Furthermore, access to a line of credit is available if needed. As you have probably noticed, a home equity loan can be pretty flexible and thus be structured in ways that can allow seniors to retire financially independently. Therefore, individuals seeking a loan should assess their financial position to determine which type of debt structure works best.
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Eligibility for a Home Equity Conversion Mortgage
Many requirements specify the pool of homeowners eligible to take up HECM loans. This section will highlight the criteria set by the U.S government for both individuals and properties that need to be met to be eligible.
It is important to note that a home equity loan is only available through the U.S. Department of Housing (HUD) approved lenders.
Borrowers need to meet the following requirements to be approved for a HECM in the United States; the HUD outlines these:
- You are 62 years of age or older.
- It would help if you had significant equity in your home, usually greater than 50%
- It would help if you used the home that is being used as collateral as your principal residence, which means you will reside in it.
- It would help if you were not delinquent on any federal debt.
- Your current financial position allows you to cover property taxes, insurance, homeowner association fees (HOA), and other charges for the ongoing future related to your property.
- You should attend a session with a HUD-approved HECM counselor pre-application to ensure you know the loan details.
Individuals should not take out a home equity loan if they plan to live in the property for a short period.
Some requirements are also set out for the property to get approved; these can also be found on the HUD website:
- A single-family home or a multifamily property classified as a principal residence means the borrower resides in it.
- An FHA single-unit-approved individual condominium or a unit in a HUD-approved condominium development
- A manufactured home that meets FHA requirements
Steps to apply
Individuals interested in applying may follow the following steps to ensure that the process runs smoothly:
- Identify HUD-approved lenders
Use HUD's lender list tool to find a lender. This tool can be used to narrow lenders by state or city. Otherwise, you can also search for lender names.
- Research the lenders
Many online resources highlight what different lenders create. You can see the costs associated with other lenders and the advantages these firms offer.
Borrower reviews are also available online with consumer complaints against the firm on the Consumer Financial Protection Bureau database.
- Get in touch
Contact the narrowed list of HECM lenders that interest you; although it is not possible to apply on the HECM lender's website, there are forms available that allow the lender to contact you.
You can talk to the lenders and work with them to ensure that basic requirements are met for the official application.
- Pre-application counseling session
As discussed before, homeowners need to attend pre-application counseling sessions with an approved lender; this allows them to understand their agreement and get advice and resources.
- Review and select an offer
Review any offer(s) you receive, and choose the best HECM for you.
Alternatives to a Home Equity Conversion Mortgage
There are a few alternatives to a home equity loan that homeowners may look into that may fit their goals and criteria better. For instance:
- Single-Purpose Reverse Mortgages
This type of reverse mortgage is very similar to a standard home equity loan, offered by some state and local governments and even some non-profit organizations.
The capital from this mortgage can only be used for home repairs or remodeling.
- Proprietary Reverse Mortgages
This is a private reverse mortgage; thus, it is not backed by the government. Hence, the terms and conditions for such an instrument vary based on the lending party.
Since this mortgage isn't government-insured, borrowers must still pay the home's value even if prices fall.
Advantages and Disadvantages
It is essential to recognize that reverse mortgages are complex instruments, and several benefits and limitations are associated with such a loan. Therefore, seniors should be aware of these factors and evaluate if the agent is worth it.
As discussed, a home equity loan can be structured in several ways. Hence, eligible individuals should evaluate which benefits and limitations are more important to them to consider which type of debt fits their purpose.
Here is a table below that summarizes these key factors:
|Monthly proceeds create current income, which can supplement retirement income or other purposes.||Processing fees are usually higher for reverse mortgages due to the complexity.|
|No income or asset requirements to qualify||The debt burden for heirs after the passing of the borrower|
|A credit score is not a factor in being eligible for a HECM; also, such a loan does not impact an individual's credit score||Higher fees than other mortgages|
|It is federally insured; therefore, borrowers are protected from falling home values.||Uncertainty in emergencies as there may be a situation that demands the homeowner to live out of their home for most of the year. This means that the mortgage comes due all at once|
|You can retain the ownership of your home.||Forced to live in your home to maintain principal residence status|
|No income tax on proceeds from a HECM; however, you should consult your tax professional for details.||Sometimes, a payment plan may not last the lifetime of a homeowner. Therefore, you may outlive your proceeds.|
|Limited liability as you want to owe more than the value of the home||Possible negative impacts on eligibility for government aid as HECM income can affect the ability to qualify for Supplemental Security Income or Medicaid, according to the Healthcare Authority|
Perhaps the most crucial advantage of a home equity loan is that homeowners can supplement retirement income using their home's equity. Therefore, this reverse mortgage can aid many families, and individuals support their retirement.
Although, one needs to consider the costs associated with such an instrument and the drawbacks of being tied to a lender. This is why individuals should assess each disadvantage and ensure they feel convinced that the mortgage is worth it.
Even if home equity loans are excellent financial instruments that can offer much to customers, some drawbacks shall be considered in a thorough analysis.
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Research and authored by Imran Husain l Linkedin
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