A HECM is a loan agreement with a financial institution that allows one to convert their home equity into monthly cash payments or a lump sum disbursement. For example, if one owned a home worth a million dollars, and the home was paid off, one could potentially receive a lump sum payment of up to $600,000. Or, if preferred, could receive approximately $3,000 per month for the rest of one’s life without paying a mortgage. The monies could then be used as desired: travel, a new car, college expenses for the grandkids, or other meaningful endeavors. In return, the lending institution will charge interest on the money borrowed. The mortgage is not due until one moves out of the house or the owner passes away.
Prior to 2009, this type of loan was known as a “Reverse Mortgage” and had a bad reputation with some consumers because of the unscrupulous sales practices. Fortunately, in 2009 the Federal Housing Administration took a stand and introduced standards and regulations that cleaned up these programs and made them a more viable option. Today, these loans are now called Home Equity Conversion Mortgages (HECM). With the new standards and regulations HECMs can now present an attractive and beneficial option to individuals that have a need.
What are the qualifications for the regulated HECMs?
One must be a titleholder of their home, 62 years of age or older, and the property must be the primary home one lives in for more than half the year. Additionally, the home must be paid off or have a low mortgage balance with no delinquent federal debt.
As with most financial retirement strategies, there are benefits and drawbacks:
- One can get access to the equity in their home without having to sell or make mortgage payments.
- The cash flow received is tax free (no increase of taxability on Social Security or Medicare premiums).
- As long as one pays for necessity housing costs (property taxes, homeowner’s association fees, homeowners insurance) the home cannot be foreclosed on, even if the amount owed is significantly more than the home’s value.
- There are a variety of payment options: lifetime monthly payment, lump sum payments, a line of credit or a combination of all the above.
- One could take out up to 60% of their home’s value depending on age, financial situation, and the type of payment option selected.
- If the balance owed is greater than the value of the property at one’s passing, heirs ARE NOT held liable for the difference.
- The fees, which could be substantial, include: appraisal fee, closing costs, origination fee, servicing fee, mortgage insurance and any point fees paid to reduce the interest rate.
- The monies received are subject to interest charges, and with time the principal owed will compound.
- The fees and the compounding interest charges will reduce the amount heirs receive upon the owner’s passing.
- If one decides to move out of their home they must sell the property immediately.
- The interest that is incurred on the mortgage does not qualify for a tax deduction until the mortgage is paid off.
Like most financial options, HECM loans are not appropriate for every situation. If one has guaranteed incomes and no need for extra liquidity, then a HECM may not make sense due to the high fees involved. Additionally, if one desires to pass maximum assets to their heirs, then a HECM may not be the best option.
HECM can be appropriate when someone has depleted most of their assets other than the equity in their home. If one still has retirement assets, let’s not forget that downsizing one’s household could potentially be a good option because it may produce extra cash needed while substantially reducing expenses. If downsizing does not make sense, and a HECM sounds like something you are interested in, make sure you do your due diligence and work with a trusted HECM mortgage specialist.