What Is a HECM?

How a HECM Works: What 'Conversion' Actually Means

The word "conversion" refers to turning part of your equity into money you can use. Equity is the part of the home's value you own free of debt. A HECM converts a portion of that equity into funds without a monthly principal-and-interest payment to the lender.

This is the reverse of a traditional mortgage. With a traditional mortgage, monthly payments bring the balance down. With a HECM, the CFPB explains, "interest and fees are added to the loan balance each month and the balance grows." As the balance rises, your equity falls. The CFPB also states plainly that a reverse mortgage "is not free money." It is a loan, and it must be repaid.

The CFPB lists several duties for the borrower. The borrower is required to live in the home as the principal residence, which is the place the borrower lives most of the year. Borrowers are also required to pay the property taxes and homeowners insurance. The loan terms also require keeping the house in good condition. Those duties last as long as the loan does.

The loan generally comes due when the last borrower dies, sells the home or no longer lives there. Those events are explained further below. To follow the steps in order, see how a reverse mortgage works.

Who Can Apply: The Basic Eligibility Requirements

Age is the first test. Under 12 U.S.C. § 1715z-20(b)(1), an eligible homeowner is one "who is, or whose spouse is, at least 62 years of age or such higher age as the Secretary may prescribe." The CFPB describes the HECM as "available only to homeowners who are 62 and older."

The home must be the principal residence of each borrower at closing. This rule is in 24 C.F.R. § 206.39. Under 12 U.S.C. § 1715z-20(d)(3), the home must be a dwelling designed principally as a 1- to 4-family residence, and the borrower must live in one of the units.

Counseling comes before the loan. Under 12 U.S.C. § 1715z-20(d)(2)(B), a borrower must receive "adequate counseling" from an independent third party. That counselor cannot be connected to or paid by a party that originates or funds the loan or that sells annuities, investments or insurance. In practice, this means the person explaining the loan has no stake in whether it is made.

The CFPB's eligibility page lists other requirements, including these:

• Enough equity. The CFPB lists owning the home outright or having a low mortgage balance that can be paid off at closing, using the borrower's own funds or the reverse mortgage money.
• No federal debt. You cannot owe federal debt such as federal income taxes, but reverse mortgage money may be used to pay it off.
• Funds for property charges. The borrower needs enough personal funds for taxes, insurance and upkeep, or an agreement to set aside part of the loan funds at closing.
• A home in good shape. If the home does not meet property standards, the lender will say which repairs are needed first.

Meeting these points does not by itself mean a loan is approved. The lender decides.

How Borrowers Can Receive the Funds

Once a loan is in place, a common question is how the money arrives. Under 12 U.S.C. § 1715z-20(d)(9), the borrower selects a payment method. The methods are:

• A line of credit. You draw funds as needed, up to the available limit.
• Monthly payments over a term. A lender pays a set amount each month for a period you choose.
• A term plan plus a line of credit.
• Monthly payments over your tenure. Payments continue while you live in the home and the loan stays in good standing under its terms.
• A tenure plan plus a line of credit.
• "Any other basis that the Secretary considers appropriate." A lender or counselor can explain whether a single lump-sum draw is offered on a given loan.

Put simply, the choice is between steady monthly income, a reserve to tap when needed, or a mix of the two.

That first choice is not always permanent. Under paragraph (d)(10), a borrower may generally switch to a different method later, though for fixed-rate loans HUD may limit that by regulation.

The amount available depends on several factors. HUD names the age of the youngest borrower or eligible non-borrowing spouse, the current interest rate, and the lesser of the appraised value, the HECM FHA mortgage limit or the sales price. HUD publishes the current limit. A lender may pay these funds only under the loan's terms and the borrower's obligations. The CFPB has more background.

Costs and Insurance: Why Your Balance Grows Over Time

Costs are a large part of why the balance grows. HECM costs typically include these charges:

• An upfront mortgage insurance premium.
• An annual mortgage insurance premium.
• An origination fee.
• Closing costs.
• A servicing fee.

FHA sets the mortgage insurance premiums and announces premium rates in Mortgagee Letters. Mortgagee Letter 2017-12 is one example; the rates that apply to a given loan are those in the most recent applicable HUD Mortgagee Letter, which a lender can identify.

Federal rules limit the origination fee, and that fee may be fully financed with the mortgage. The lender discloses the actual amount. Financing costs into the loan means they are not paid in cash. Instead, they are added to the balance, and interest builds on them too.

Interest also accrues month by month on everything owed. The FTC warns that this "can use up much – or even all ─ of your equity."

Federal law requires several disclosures that help you see these costs. Under 12 U.S.C. § 1715z-20(d)(2)(C), costs must be fully disclosed, showing which charges are required and which are not. Under subsection (e)(4), the lender must give a projected total cost before closing. Under subsection (e)(3), you receive an annual statement, no later than January 31, that shows what was paid to you, the interest added and the balance.

When the Loan Comes Due: What Your Family Needs to Know

For many families, the hardest question is what happens to the house later. Under 24 C.F.R. § 206.27(c), the loan becomes due in full in these cases:

• A borrower dies. It comes due if the home is no longer the principal residence of a surviving borrower. If an Eligible Non-Borrowing Spouse meets HUD's requirements, repayment can be deferred.
• The borrower transfers title. It comes due when a borrower conveys all title in the property and no other borrower keeps title.

The loan can also become due, with the Commissioner's approval, in these cases:

• The home stops being a principal residence. This applies when it is not the principal residence of any other borrower.
• A long absence because of illness. A borrower is away for more than 12 consecutive months because of physical or mental illness, and no other borrower lives there.
• Unpaid property charges.
• Another loan obligation is not performed.

In everyday terms, the loan runs as long as a borrower lives in the home and keeps up with its basic duties; the last two items mean that missing taxes, insurance or upkeep can bring repayment sooner. When the loan comes due, the borrower or the heirs repay it. The CFPB says this is "usually by selling the home," though other funds or new financing may also be used to keep it.

There is one important protection. Under 12 U.S.C. § 1715z-20(d)(7), the homeowner is generally not liable for any shortfall between the balance and the net proceeds from the sale. The FTC describes this as owing no more than the home's value when the loan becomes due and the home is sold.

HECM as One Option Among Several

A HECM answers some needs and not others, so the wider picture matters. The CFPB names other choices, and each one gives up something different:

• A budget and benefits review. This may lower costs. The CFPB points to benefitscheckup.org and to local help with utilities and repairs.
• Property tax relief. The CFPB mentions checking with the county or town tax office.
• Help from family. This keeps borrowing out of the picture but depends on what relatives are able to give.
• A home equity loan or line of credit. These require monthly payments, and the balance falls as it is repaid. See reverse mortgage vs HELOC.
• A cash-out refinance. This replaces the existing mortgage with a larger one and requires monthly payments.
• Selling and downsizing. This frees equity but means leaving the home.
• Waiting. The CFPB notes that borrowing too young may leave less money later.

The trade-off with a HECM is that monthly cash flow is spared while costs build up in the balance. Which choice fits depends on income, goals and plans for the home. For homeowners who still owe on a mortgage, see retiring with a mortgage still owed.

A HUD-approved counselor can talk through these options. HUD's page links to the HECM Counselor Roster, and the number (800) 569-4287 is also available.

A HECM is one path, and seeing the full picture helps you or your family weigh it honestly against the others.