Basics of Reverse Mortgages (aka HECMs)
What The Heck’s a HECM?
Pronounced Heck-Em, a Home Equity Conversion Mortgage is a type of Reverse Mortgage loan that is insured through the Federal Housing Administration (FHA) and is used to covert your home’s equity into tax-free* cash, without having to make any monthly mortgage payments. You must continue to pay taxes, insurance, and maintain the home. Instead of monthly payments, this loan is repaid once the last remaining borrower leaves the home.
Eliminates your monthly mortgage payment.
A Reverse is the only mortgage that never requires a payment until you move from your home or pass away. If you currently have a mortgage, a HECM could eliminate your current monthly payment and give you access to any additional cash you qualify for that is currently tied up in equity. Homeowners are required to continue to pay for property taxes, homeowner’s insurance, and maintain the home.
Buys your retirement home.
The HECM for Purchase (H4P), will help you buy your dream retirement home without the required monthly payments…except for general maintenance, taxes and insurance.
Sets you up with a growing Line of Credit.
A HECM line of credit is guaranteed to grow (applies to unused funds), and today it starts at about 5%. The earlier you set up the credit line, the more compounding occurs, so you’ll have access to cash from a substantial line of credit in your later years when you are most vulnerable and will need it the most.
Shore up your lines of credit when you do not need them so they are in place when you do.
What’s the Catch?
Not everyone qualifies.
According to the rules set by the US Department of Housing and Urban Development (HUD), at least one borrower must be age 62; they must maintain the property as the primary residence and continue to pay the property taxes and homeowners insurance. Although credit scores are not a factor, borrowers must demonstrate a willingness and capacity to pay for basic maintenance, plus the taxes and insurance.
How Does It Work?
To understand a Reverse Mortgage, you first must visualize how a forward or traditional mortgage works…Cash To Equity
In a familiar traditional mortgage, it’s designed to turn cash into equity. With each monthly payment you take after tax cash money and pay it into equity. The first dollars of each monthly payment pays all the interest due for that month…every dollar above this required interest payment goes towards reducing the principle loan balance to build equity.
NOTE: A forward mortgage requires you to make monthly payments every 30 days…this is how the lender collects interest on the money they lend. If you don’t pay, you can lose your home. It is quite common that a family will pay two or three times the loan amount in interest over time.
…In a forward or traditional mortgage you are paying cash into interest first, in order to build equity.
The principle concept of a Reverse Mortgage… is to turn Equity into Cash.
Building equity in your 30’s, 40’s and 50’s is great…you want as much equity as you can possibly build. However once you turn 62 you want to convert that equity into cash. Equity has No practical value, until you turn it into cash.
This is a vital concept worth repeating: Equity does you absolutely no good, until you or someone turns it into cash!
Your Home’s equity is an asset.
It’s up to you when and how that equity will be converted to cash, and who benefits from it.
The structure of a Reverse Mortgage Loan has three main components:
- Borrowers Age
EQUITY: represents the difference between the value of the home and any loans against that home. A home worth $350,000.00 with an outstanding loan balance of $200,000.00 is said to have $150,000.00 worth of equity. A $400,000.00 home that is owned outright, with no outstanding mortgages against it, is said to have $400,000.00 worth of equity.
A Reverse mortgage requires the homeowner to have a substantial amount of equity in the home. The reverse mortgage lender will only lend against a portion of the available equity (between 40%-60%). The lender requires a large reserve of equity be set aside in order to accommodate the potential for a growing loan balance.
Because a reverse mortgage does not require a borrower to make any monthly payments (must still pay taxes, insurance, and maintain the home), the payment of interest is deferred and held in the form of a growing loan balance. This balance is generating interest, and is referred to as Negative Amortization. The lender will not require repayment of the loan balance until the last remaining borrower leaves the home permanently.
Another assumption made by reverse lenders is home price appreciation over time. Even through the ups and downs of the marketplace, over the long haul we assume your home will go up in value. Because we’ve held aside a reserve of equity and your home is going up in value, we can account for the growing loan balance without the risk of you getting upside down in the home.
Think of it this way:
You have paid into your home for many years building equity. At 62, you can now reverse it and convert a portion of that equity into cash.
The underwriter will determine what portion of your equity they will approve or what limit of the available equity you can borrower. This figure is referred to as the Principle Limit. It will be based upon the age of the youngest borrower and considers the average mortality rates and life expectancy.
The older the borrower the larger the principle limit. Because of a shorter life expectancy, the more cash the borrower can receive. For example; at age 70 the borrower can expect the principle limit to be approximately 40% of the home’s value. At age 80, the principle limit is about 50%. The older you are the more cash you can receive.
Think of this way: The lender is always going to structure the reverse mortgage to ensure there is equity capacity within the value of the home to accommodate the growing loan balance, knowing they’ll need to collect all the interest and principle, once the last remaining borrower leaves the home.
Sustainability: The founding principle behind the design of the Reverse Mortgage was to enable retirees to age in place, while tapping into the home’s equity to extend and enhance retirement incoming planning.
The whole purpose was to ensure people could live in their home to the end of retirement, pull cash out of the home without triggering a required monthly payment.
In this context, sustainability means the borrowers can maintain and sustain ownership.
This requires them:
To live in and…maintain the home as the primary residence
Pay the annual property taxes…
Pay and keep current on the homeowners insurance…
Although traditional credit scores carry no weight in the underwriting or approval of the loan, borrowers do need to demonstrate a willingness to pay their obligations.
This means we do review a person’s credit to determine whether there is a history of delinquency, or a pattern of disregard for credit obligations. Letters of explanations will be expected when the underwriter sees excessive late payments, outstanding judgments or collections.
As part of the ability to sustain the reverse mortgage and stay in the home, we will look at the borrower’s mandatory monthly obligations against the amount of household income. Depending on the number of people in the household, we will verify minimum amounts of discretionary income to ensure the borrowers can afford to pay for taxes and homeowners insurance.
NOTE: The lender and the investors, who buy the bonds generated by pools of Reverse mortgages, are playing the long game. Because they are not collecting monthly interest payments, capital investors know very little interest will be collected in the first few years, however when people move, sell or pass away the investors will collect large lump sums of interest when the loan balance becomes due in full.