Updated: Jun 9, 2023, 2:14pm

What Is A Home Equity Conversion Mortgage?Getty

A home equity conversion mortgage (HECM) is a reverse mortgage that enables seniors to access their home equity without selling their homes or making monthly mortgage payments.

HECMs are the most popular type of reverse mortgage available. Nearly 65,000 senior homeowners took out a HECM from Oct. 1, 2021 through Sept. 30, 2022, according to the National Reverse Mortgage Lenders Association.

How Do Home Equity Conversion Mortgages Work?

Instead of gradually paying a lender back each month, all the money you borrow with a HECM is due when you move out of your house. That sum consists of the principal, interest and mortgage insurance—and closing costs if you finance them. Your move might be caused by your death, a need for assisted living or another reason.

You can borrow the money as a:

  • Lump-sum payment
  • Series of monthly payouts
  • Line of credit
  • Combination of monthly payouts and a line of credit

The lump sum has a fixed interest rate while the other options have a variable interest rate. Regardless of the option you choose, you can use your HECM proceeds however you want and continue to own your home.

The amount you can borrow is based on three factors:

  • Your home’s value
  • The youngest borrower’s age (or the youngest eligible non-borrowing spouse’s age)
  • Reverse mortgage interest rates

Experts: Consider HECM Lines of Credit

Like any mortgage product, HECMs come with notable risks, including being used to scam seniors out of their home equity. However, these loans also have a legitimate purpose and can be a good tool for borrowers who need to supplement their income during their retirement years.

Some retirement planning experts have advocated for broader use of the HECM line of credit option. They say seniors should set one up as soon as they’re eligible. Even if you don’t need it now, the line of credit grows over time and can provide a diversified source of retirement income.

For example, you could tap your home equity in years when you might otherwise have to sell investments at a loss to pay for living expenses or medical costs. You won’t pay interest unless you actually borrow money. But you’ll pay closing costs to set up the line of credit, whether you use it or not—which can be a deterrent.

Who Is Eligible for a HECM Loan?

You must meet these basic requirements to qualify for a HECM:

  • Age. You must be at least 62 years old.
  • Use. You must live in the home as your primary residence.
  • Equity. You must have substantial home equity.
  • Financials. You must be able to keep paying property taxes and homeowners insurance and keep your home in good repair. If not, the lender must set aside money from your HECM to pay these costs on your behalf, which means you won’t be able to borrow as much.
  • Education. You must complete reverse mortgage counseling with a U.S. Deptartment of Housing and Urban Development (HUD)-approved counselor to make sure you understand how a HECM works.

How To Apply for a HECM Loan

HECM loans are only available through reverse mortgage lenders approved by the Federal Housing Administration (FHA). You can find one through the FHA’s website or find lenders first, then check with the FHA to make sure they’re approved. If possible, it’s best to get preapproved or prequalify with multiple lenders to find the best offer before submitting an official application. Preapproval and prequalification have no impact on your credit score.

The government has many requirements lenders have to follow when issuing HECMs. However, it doesn’t tell lenders what interest rate to charge. A lender with lower fees may charge a higher interest rate.

Fees and other closing costs can vary by lender, although HECM lenders can’t charge more than $6,000 in origination fees. No matter which lender you choose, you can shop around for better prices on third-party closing costs, such as title insurance and closing services.

You’ll also want to pay attention to how much and how often the interest rate can change if you apply for a HECM with a variable rate.

HECM vs. Reverse Mortgage

All HECMs are reverse mortgages, but not all reverse mortgages are HECMs. Some lenders offer their own proprietary reverse mortgages.

HECMs are tightly regulated by HUD, with protections for both borrowers and lenders. All lenders must follow HUD’s rules. Proprietary reverse mortgages, on the other hand, have more lenient requirements, with more room for lenders to set their own parameters.

Mortgage Insurance Premiums

One of the most notable rules is that you’ll have to pay mortgage insurance premiums (MIPs) when you get a HECM. The upfront premium costs 2% of your home’s value (the maximum claim amount); ongoing premiums cost 0.5% of the outstanding loan balance each year.

HECMs have a government guarantee that limits lenders’ losses if the borrower owes more than the home is worth when the mortgage is due. This guarantee also prevents borrowers and their heirs from having to make up any shortfall.

As a result, all HECM borrowers must pay MIPs that go into the guarantee fund that helps make these loans possible. Proprietary reverse mortgages don’t have this mortgage insurance requirement.

Age Requirements

Another key difference is that you must be at least 62 years old to get a HECM. You may be able to get a proprietary reverse mortgage at a younger age, such as 55, depending on the lender and your state.

Borrowing Limits

A proprietary reverse mortgage also allows you to borrow far more—into the millions, depending on the lender and how much your home is worth. It can be a good option if you want to borrow more than HUD allows with a HECM, based on a maximum home value of $1,089,300 in 2023.

HECM Alternatives

A key reason for choosing a HECM is that you don’t meet the income or credit requirements to get another type of loan. But there are many other ways to use your home equity in retirement—and borrow without using your home as collateral.

You don’t have to be working to qualify for a loan. You can get a mortgage after retirement (or get another type of loan) based on your retirement income, including Social Security, Supplemental Security Income, retirement account withdrawals, pension payments and more.

financial advisor can help you decide whether a HECM or an alternative option below may best meet your goals.

  • Home equity loan: This lets you borrow a lump sum of cash against your home’s value. You repay home equity loans through fixed monthly payments over a set number of years at a fixed interest rate.
  • Home equity line of credit (HELOC): Much like a credit card, HELOCs let you access a credit line that you can use as needed versus a lump sum amount. You pay interest only on what you borrow, not the full amount of your credit line. The interest rate is variable, and your monthly payments may fluctuate. Some HELOCs let you convert sums you’ve borrowed into a fixed rate.
  • Cash-out refinance: A cash-out refinance replaces your existing home loan with a new, larger mortgage that pays out the difference in cash. While cash-out refis are most often used when you’re repaying an existing mortgage, you can also use them on a paid-off home.
  • Personal loan: Personal loans typically have lower borrowing limits and higher interest rates than a home equity loan, line of credit or cash-out refi but don’t use your home as collateral. They have fixed interest rates and steady monthly payments, but the loan terms are usually much shorter.
  • Credit card: When you open a credit card, you’ll have access to a predetermined credit limit that you can use as needed and pay interest only on what you borrow. Interest rates are variable and may go up to 30%, depending on your creditworthiness. While you’re expected to repay your balance monthly, you’re only required to pay your minimum payment. Unpaid balances will be charged with interest.

By Amy Fontinelli