The Pros, Cons, and Alternatives of a Home Equity Conversion Mortgage

Reverse Mortgage Explained

A Home Equity Conversion Mortgage (HECM), commonly known as a reverse mortgage, allows homeowners aged 62 and older to convert a portion of their home equity into cash. Unlike a traditional mortgage, where borrowers make monthly payments to a lender, a reverse mortgage eliminates the borrower’s monthly payments entirely. This can seem like some sort of dark financial wizardry – turning your home equity into cash without monthly payments! Surely it’s got to be a trick. It’s easy to see why they’re sometimes misunderstood.

As strange as this may seem to most homeowners, they may never need to pay another cent to the lender for as long as they live. The loan is only required to be repaid when the homeowner sells the home (which is a no-brainer) or passes away. If the borrower no longer resides on the property (e.g. moves to a family member’s home, moves to an assisted living facility, or travels extensively away from home for more than 6 months a year), that may also require the loan to be repaid.

• HECMs are FHA-insured reverse mortgages, meaning they are backed by the federal government and adhere to strict regulations to protect borrowers.
• Proprietary reverse mortgages are private loans that do not have FHA insurance. They may allow for higher loan amounts but often come with higher interest rates and different qualification criteria compared to HECMs. Any reverse mortgage that is not a HECM is a proprietary loan.
• Not all reverse mortgage borrowers receive direct payments. The most popular way to access home equity through a reverse mortgage is through a line of credit. This credit limit grows at the same rate as the reverse mortgage itself, providing a great deal of flexibility over time for the homeowner. Other options include:
  • A lump sum payout at closing (the least advisable unless the borrower has an extraordinary need for a large amount of money immediately).
  • A monthly stipend to supplement income.
  • A combination of the line of credit and the monthly stipend.
• Reverse mortgage proceeds are not taxable because they are considered loan advances rather than income. However, if the borrowers invests these funds in a certificate of deposit (CD), a security or other interest earning account, any interest or returns earned may be subject to taxation.

Practical Tip: Before applying for a reverse mortgage, assess your long-term financial goals to determine if this loan aligns with your needs. All HECM borrowers are required to meet with an approved Revers Mortgage Counselor like Money Fit by DRS.

Responsibilities of a Reverse Mortgage Borrower

While a reverse mortgage eliminates monthly payments, borrowers must still take care of understandable financial obligations to keep their loan in good standing.

• Borrowers are required to pay property taxes.
• Borrowers must continue to have homeowners insurance in place and paid.
• The home must be maintained in good condition, but this does not mean lenders will monitor the property, peak through the windows, or sneak around the back to check out the condition of the home. Inspections generally occur only if the home is condemned by the city or county, or if a government tax lien is placed against it.
• If a borrower marries or remarries after obtaining a HECM, their new spouse will not automatically have rights to remain in the home after the borrower passes away. Unless the new spouse is added to the loan through refinancing, they may need to repay the full loan balance or move out within a year of the borrower’s death.

Practical Tip: Set up automatic payments for property taxes and insurance to avoid any risk of defaulting on your reverse mortgage.

Is a Reverse Mortgage a Good Idea?

A reverse mortgage can provide financial relief or a comfortable budgeting cushion for retirees, but it may not be the right choice for everyone. Before making a decision, homeowners should consider their current financial situation, future expenses, and alternatives.

• A reverse mortgage can supplement retirement income, cover medical expenses, or pay off existing debt.
• If a borrower moves out of the home for more than 6 months during a 12-month period, the loan may become due.
• Reverse mortgages reduce the amount of equity that heirs may inherit.

Practical Tip: Speak with a financial advisor to explore whether a reverse mortgage aligns with your retirement strategy and future plans. Then, plan to meet with a HUD-approved HECM counselor to understand the advantages and disadvantages of HECMs.

Reverse Mortgage Requirements HUD

To qualify for a HECM, borrowers must meet specific eligibility criteria set by HUD. These requirements ensure that borrowers can responsibly manage the financial obligations associated with the loan.

• Borrowers must be at least 62 years old and own their home outright or have a low remaining mortgage balance.
• The property must be a primary residence and meet FHA property standards.
• Applicants must undergo a financial assessment to determine their ability to cover taxes, insurance, and maintenance costs.
• Younger borrowers typically need around 60% equity in their home to qualify, while older borrowers may need slightly less than 50% equity. If the borrower’s equity falls short of this requirement, they may need to bring enough cash at closing to make up the difference.

Practical Tip: Keep all required documentation organized and ready, such as proof of age, property ownership, and financial records, to streamline the application process.

Alternatives to a Reverse Mortgage

While a reverse mortgage can be a helpful financial tool, it is not the only option available to homeowners looking to access additional funds in retirement.

• A home equity loan (HEL) or line of credit (HELOC) allows homeowners to borrow against their equity while retaining full ownership. The advantage of HELs and HELOCs is that the homeowner can typically access much more of their home’s equity than they can through a HECM. The main disadvantage is that the homeowner must begin making payments on the HEL or HELOC the following month.
• Downsizing to a smaller home can free up equity while reducing living expenses and minimizing the physical demands on the borrower and they age. Most HECM borrowers, in our experience, have no desire to move and hope to make their current home their forever home.
• Retirement account withdrawals may provide additional financial support if the homeowner has enough to cover their living expenses. However, it’s no surprise that most retirees enter retirement with fewer financial resources than they need to sustain their current lifestyle.
• Government assistance programs may assist many retirees who cannot afford to live or maintain their home and have to consider renting again.

Practical Tip: Compare different financial options, including potential costs and benefits, before deciding whether a reverse mortgage is the best choice for your situation. This must be part of any discussion you have with a HUD-approved HECM counselor when trying to get the required certificate.

Reverse Mortgage Counseling Certificate

Before obtaining a HECM, HUD requires all applicants to complete counseling with an approved housing counselor. This ensures that borrowers fully understand the risks, costs, and benefits of a reverse mortgage.

• Counseling sessions provide information on loan terms, repayment requirements, and alternative options.
• After completing counseling, borrowers receive a Reverse Mortgage Counseling Certificate, which must be submitted with their loan application.
• The session can be conducted in person, over the phone, or via video conference.
• A non-borrowing spouse (who is either not on the deed or under 62) is also required to attend the counseling session to ensure they understand their rights and protections under the loan.
• You should expect to incur a small fee for these sessions. Fees can be paid at the end of the counseling session or, to avoid any out-of-pocket expenses, can be added to the loan’s closing. The cost of the session will vary from agency to agency, but not surprisingly, agencies with lower fees often have waiting lists that stretch out for weeks if not months.

Practical Tip: Choose a HUD-approved housing counselor like Money Fit who specializes in reverse mortgage guidance to ensure you receive accurate and reliable information. Find an approved agency here.

Do I Need Reverse Mortgage Counseling?

HUD mandates reverse mortgage counseling for all HECM applicants to promote informed decision-making. This requirement protects borrowers from entering into a loan agreement without fully understanding the potential consequences.

• Counseling sessions help homeowners weigh the pros and cons of a reverse mortgage.
• Borrowers can ask questions about loan terms, repayment expectations, and financial risks.
• Certified counselors provide unbiased guidance and ensure compliance with HUD regulations.
• Counseling sessions typically last 60 to 90 minutes but can last longer for clients who have lots of questions or who may have more difficulty understanding reverse mortgages.
• Counselors are required to verify that the potential HECM borrower has a minimum level of understanding of the HECM loan product before issuing a certificate.

Practical Tip: Schedule your counseling session early in the application process to avoid delays in obtaining your reverse mortgage.

Making the Right Choice for Your Future

Home Equity Conversion Mortgage (HECM) can be a valuable financial tool for retirees, but it’s essential to understand that, like any form of financial wizardry, it comes with both benefits and risks. By meeting HUD requirements, exploring other financial options, and completing reverse mortgage counseling, homeowners can make informed decisions that align with their financial goals. If you’re considering a reverse mortgage, take the time to research and consult with professionals to ensure this particular spell is the right one for your housing goals – one that truly turns your equity into the financial freedom you’re seeking.