Home Equity Conversion Mortgage Explained

By Laurel Tincher · May 15, 2024 · 9 minute read

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Home Equity Conversion Mortgage Explained

A home is a place to live, but it is also a significant asset that often increases in value over time. Until a sale or an inheritance, this value typically remains unrealized. However, a Home Equity Conversion Mortgage (HECM) is a tool that can help unlock some of a home’s equity for those who are experiencing unforeseen expenses or want financial flexibility in retirement.

What are home equity conversion mortgages, and how do they operate? We’ll delve into the complexities of HECMs in this article, going over their advantages, requirements for qualifying, available repayment plans, and any drawbacks.

What Is an HECM?

Knowing how to safely utilize home equity can be a game-changer in an environment where traditional retirement funding may not be sufficient and the cost of living is rising. With the help of HECMs, homeowners 62 years of age and over have a way to turn a portion of their equity into cash without having to worry about making monthly mortgage payments or refinancing.

A Home Equity Conversion Mortgage is a specific kind of home loan that allows homeowners 62 years of age and over to access a portion of their home equity. The loan is insured by the Federal Housing Administration (FHA). With an HECM, the lender pays the borrower instead of the borrower making monthly payments to the lender as is the case with standard home loans. These funds may be obtained in the form of a line of credit, monthly installments, a lump sum, or in any combination of these. One of the key characteristics of a HECM is that repayment is usually postponed until the borrower either stops using the house as their principal residence or defaults on other loan responsibilities, like upkeep, property taxes, and insurance.

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How HECMs Work

With HECMs, qualified homeowners 62 years of age and over can convert a part of their home equity into cash without having to sell their house or pay a monthly mortgage. A homeowner who obtains this type of home equity loan has the choice of receiving money in one of several ways: as a lump sum, as monthly installments, as a line of credit, or as a mix of these. A number of variables, including the borrower’s age, the home’s appraised value, and the current interest rate, affect how much money is available through a HECM.

Borrowers are still liable for upkeep, property taxes, homeowners insurance, and any relevant homeowners association dues, and they must continue residing in the home. Usually, the borrower must make loan repayments when they sell their house or move out permanently. If the owner dies, his or her heirs are responsible for repaying the remaining loan total, which includes all accumulated interest and fees. (The funds to repay the total might be recouped through the sale of the house.) With the help of this financial tool, retirees can access their home equity and keep ownership and occupation of their residence, giving them more financial stability and freedom in their later years.

Home Equity Conversion Mortgage Requirements

There are several requirements to quality for an HECM:

Age

To qualify for a Home Equity Conversion Mortgage, applicants must be aged 62 or older.

Homeownership

Homeownership is a prerequisite for obtaining an HECM, and the property must be the borrower’s primary residence.

Equity

Sufficient equity in the property is required for eligibility. Typically the borrower must have at least 50% ownership.

Financial Assessment

Lenders perform a rigorous financial review before approving a HECM to make sure borrowers can afford regular costs like property taxes and insurance. Although there are no stringent income or credit restrictions for HECMs, borrowers still need to show that they can afford their debts.

Property Type

The eligibility for a Home Equity Conversion Mortgage depends on the property type. It must be a single-family home, a two-to-four-unit dwelling with one unit occupied by the borrower, or a HUD-approved condominium or manufactured home meeting FHA requirements.

Repayment

Repayment of an HECM typically occurs when the borrower sells the home, moves out permanently, or passes away, at which point the loan balance, including accrued interest and fees, is repaid either through the sale of the home or by the borrower’s heirs.

Compliance

Compliance with all FHA guidelines and requirements throughout the life of the loan is essential for borrowers of a Home Equity Conversion Mortgage.

Pros and Cons of HECMs

While there are many benefits to an HECM, there are also some downsides to be aware of.

Pros of HECM

•   Financial flexibility: Retirees who qualify for HECMs can use their home equity as a source of additional income without having to pay a monthly mortgage.

•   Retain homeownership: During the loan period, borrowers may continue living in their house and retain ownership.

•   Delayed repayment: To provide borrowers and their family peace of mind, loan repayment is normally postponed until the borrower sells the house, moves out permanently, or passes away.

•   Flexible payment options: To accommodate different financial needs and preferences, HECMs offer a range of payment options, such as lump sum payments, monthly installments, a line of credit, or a mix of these.

•   FHA insurance: The FHA insures HECMs, providing lenders and borrowers with extra security against possible losses.

•   Non-recourse loan: Since HECMs are non-recourse loans, as long as the property is sold to pay off the debt, borrowers or their heirs are not liable for any shortfall in the event that the loan total exceeds the value of the home upon repayment.

Cons of HECM

•   Accrued interest: As interest is applied to the loan balance over time, it may decrease the amount of equity that is available to borrowers or their heirs when the loan is repaid.

•   Costs up front: The money obtained from the loan may be reduced by upfront expenses associated with HECMs, such as mortgage insurance premiums, origination, closing, and servicing fees.

•   Impact on inheritance: Using an HECM to access home equity may cause the borrower’s estate to lose value, which may have an impact on the inheritance that heirs get.

•   Strict property restrictions: Eligibility is restricted to specific types of properties, which may prevent some borrowers from using this financial instrument.

•   Effect on government benefits: One may not be able to obtain means-tested government benefits like Medicaid or Supplemental Security Income (SSI) if they get funds from an HECM.

•   Potential default: Should the borrower or their heirs neglect to fulfill the loan obligations — which include upkeep of the property, payment of taxes, and maintenance of insurance coverage — they run the risk of going into default and losing the house.

Home Equity Conversion Mortgage vs Reverse Mortgage

Although they are sometimes used interchangeably, reverse mortgages and home equity conversion mortgages differ in a few important ways. Both let homeowners 62 and older access their home equity without having to pay a monthly mortgage. A mortgage with particular standards and protections that is guaranteed by the Federal Housing Administration is known as an HECM. Conversely, private lenders may provide reverse mortgages, which may have different terms and qualifying requirements. Here’s a quick look at the differences:

Feature

HECM

Reverse Mortgage

Insurer FHA Private lenders
Eligibility Requirements Strict FHA guidelines Lender-specific criteria
Costs FHA mortgage insurance premiums, fees Vary by lender/td>
Repayment Deferred until borrower moves Varies (e.g., lump sum, monthly payments)
Property Requirements FHA-approved properties Vary by lender
Government Benefits Impact DPotential impact Potential impact

Each type of mortgage has benefits and drawbacks. HECMs have upfront charges and property restrictions, but they also provide government insurance, more stringent qualifying requirements, and protection against default. Private lender reverse mortgages could be more flexible and have fewer initial expenses, but there might be risks and alternative terms for the borrower. Before making a choice, homeowners should carefully weigh their options and speak with a financial advisor.

Alternatives to HECMs

There are other options to take into consideration. One option is a cash-out refinance, in which homeowners can obtain cash for the difference when they refinance their current mortgage for a bigger sum than what they presently owe. Another choice is a home equity line of credit (HELOC) or a home equity loan; these enable homeowners to take out a loan with fixed or variable interest rates and repayment conditions based on the equity in their house.

A homeowner who wants financial freedom, without the hassles of an HECM or reverse mortgage, can look into alternative retirement income options like investments or annuities or downsize to a smaller, more inexpensive house. Before choosing one of these options, homeowners should carefully weigh their options, taking into account things like fees, payback terms, eligibility restrictions, and long-term financial objectives. Speaking with a financial advisor can also offer insightful advice on how to choose which course of action is appropriate for one’s particular circumstances.

Home Loan Rates

A number of economic factors, such as market demand, monetary policy decisions, and inflation, affect home loan rates. Mortgage lenders typically modify their rates in response to changes in the overall interest rate environment. With a fixed interest rate that stays the same for the duration of the loan, fixed-rate mortgages give borrowers stability and predictable monthly payments.

Adjustable-rate mortgages (ARMs), on the other hand, start off with lower rates and come with the ability to change them at any time depending on the state of the market. This could result in changes to the monthly payment amount. Individual mortgage rates are also influenced by loan terms, credit score, and size of down payment; consumers with higher credit scores typically obtain lower rates. It is possible for borrowers to obtain reasonable rates that are customized to their financial situation by staying up to date with market developments and looking into choices with various lenders.

The Takeaway

A homeowner age 62 or over who wishes to stay in their house but also wants to unlock some of the equity in the property to cover expenses may find a Home Equity Conversion Mortgage is worth a look. But an HECM isn’t the only option, so weigh the pros and cons and consider a home equity loan or line of credit as well.

SoFi now offers flexible HELOCs. Our HELOC options allow you to access up to 95% of your home’s value, or $500,000, at competitively low rates. And the application process is quick and convenient.

Unlock your home’s value with a home equity line of credit brokered by SoFi.

FAQ

What is the downside of an HECM loan?

The drawbacks of an HECM loan are the possibility of accumulated interest, upfront expenses such mortgage insurance premiums and taxes, and potential effects on the borrower’s eligibility for government benefits or on the value of their estate.

What is the difference between an HECM mortgage and a reverse mortgage?

An HECM mortgage is a subset of a reverse mortgage that is insured by the FHA, providing specific protections. Reverse mortgages can be offered by private lenders and may have different terms and eligibility criteria.

What is the homeowner requirement to qualify for a home equity conversion mortgage?

To qualify for a Home Equity Conversion Mortgage, the homeowner must be aged 62 or older and have sufficient equity in the property, which must serve as their primary residence.


Photo credit: iStock/Hispanolistic

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¹FHA loans are subject to unique terms and conditions established by FHA and SoFi. Ask your SoFi loan officer for details about eligibility, documentation, and other requirements. FHA loans require an Upfront Mortgage Insurance Premium (UFMIP), which may be financed or paid at closing, in addition to monthly Mortgage Insurance Premiums (MIP). Maximum loan amounts vary by county. The minimum FHA mortgage down payment is 3.5% for those who qualify financially for a primary purchase. SoFi is not affiliated with any government agency.

²To obtain a home equity loan, SoFi Bank (NMLS #696891) may assist you obtaining a loan from Spring EQ (NMLS #1464945).

All loan terms, fees, and rates may vary based upon individual financial and personal circumstances and state.

You may discuss with your loan officer whether a SoFi Mortgage or a home equity loan from Spring EQ is appropriate. Please note that the SoFi member discount does not apply to Home Equity Loans or Lines of Credit brokered through SoFi. Terms and conditions will apply. Before you apply for a SoFi Mortgage, please note that not all products are offered in all states, and all loans are subject to eligibility restrictions and limitations, including requirements related to loan applicant’s credit, income, property, and loan amount. Minimum loan amount is $75,000. Lowest rates are reserved for the most creditworthy borrowers. Products, rates, benefits, terms, and conditions are subject to change without notice. Learn more at SoFi.com/eligibility-criteria.

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In the event SoFi serves as broker to Spring EQ for your loan, SoFi will be paid a fee.

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