A home equity conversion mortgage (HECM) is a type of Federal Housing Administration (FHA) insured reverse mortgage. Home equity conversion mortgages allow seniors to convert the equity in their home to cash. The amount that may be borrowed is based on the appraised value of the home (subject to FHA limits), and the age of the borrower (borrowers must be at least 62 years old). Money is advanced against the value of the equity in the home. Interest accrues on the outstanding loan balance, but no payments must be made until the home is sold or the borrower(s) die, at which point the loan must be repaid entirely.
Home equity conversion mortgages are a popular type of reverse mortgage and can be compared to other privately sponsored reverse mortgage products offered by banks. Generally reverse mortgage terms can vary with privately sponsored reverse mortgage products potentially allowing for higher borrowing amounts with lower costs than HECMs. HECMs however will typically offer lower interest rates for borrowers. The economics of a HECM versus a privately sponsored reverse mortgage will depend on the borrower’s age and how long the borrower expects to live or own the home. Many types of reverse mortgages will exclusively target seniors with no requirements for repayment until the borrower sells their home or dies.
A HECM can also be considered in comparison to a home equity loan. A home equity loan is also a type of reverse mortgage since borrowers are issued a cash advance based on the equity value of mortgage collateral. A home equity loan will have standard borrowing terms including steady monthly interest payments.
The Federal Housing Administration sponsors the home equity conversion mortgage and provides insurance on the products. The FHA also sets the guidelines and eligibility for these loans. Borrowers can only obtain HECMs from banks where the FHA sponsors the product. To obtain a home equity conversion mortgage a borrower must complete a standard application providing required information.
To obtain approval a borrower must meet all of the product’s requirements. Requirements will be based on the borrower’s profile, their financial situation and the collateral value of the property. A borrower must be 62 years old with a qualifying property that has been substantially paid off with significant equity available. While HECM loans do not require borrowers to make monthly payments certain fees are associated with the loan closing and servicing of the loan.
Example: Seniors Reverse Mortgage To Downsize
Client couple: 80 years old in fair health; house and lot too much for them and really want a smaller one story. FMV of home is $1.2M assuming improvements will be made; cost stated below. Outstanding mortgage is $150K. They are considering $900K one story condo / townhome.
Clients considered a Guild Reverse Mortgage and decided to apply. They were approved to borrow up to 50% of the condo sale price and signed the loan agreement. They then initiated the recommended improvements and listed their home. The Lender was not involved in the sales process, and no buyer notice was required.
Sale of Current Home
House sale price $1,200,000
Less cost of sales:
Home prep: $75,000
Sales cost @ 5%: $60,000
Closing costs: $12,000
Cash Proceeds: $903,000
Note: Any profit realized may be subject to capital gains taxes, the amount of which, is dependent on several factors and the sellers’ tax bracket. Sellers should consult a professional tax accountant to determine what if any tax is due base upon the amount realized once all costs of sales and eligible improvements are deducted from the sale price. See Capital Gains Tax tab on this site for more information on capital gains tax aqnd exclusions.
Purchase of New $900,000 Condo / Townhome
Reverse Mortgage Approach
Closing costs: $10,000
Down payment: $450,000
Cash required: $460,000
Note: Mortgage amount is $450K; clients will receive a monthly mortgage bill which they DO NOT pay. It’s meant to keep them abreast of the loan balance, which will be cleared upon sale up to the FMV sale price.
Banked cash ($903,000-$460,000): $443,000
If they had gone the conventional approach, they would have had to buy the condo for all cash given their age and income stream. Here is how that transaction would have looked:
Payment for new house – all cash: $900,000
Plus closing costs: $10,000
Cash required for purchase: $910,000
Banked cash: ($903,000 – $910,00) ($7,000)
Reverse Mortgage Advantage: $450,000 more to live on!
Note: Lender cannot demand sale if outstanding mortgage amount exceeds the Fair Market Value. Sale price, however, must be based on Lender’s independent appraisal. If the sale price is less than the outstanding mortgage, the Lender absorbs the loss as it does in a foreclosure and the owners come out even.