FHA HECM

FHA HECM Defined

The Federal Housing Administration (FHA) Home Equity Conversion Mortgage (HECM) is the formal name for the most common type of reverse mortgage. The product was created by the US Government in 1987 and the first loan was closed in 1989. There was a slow uptake in the 1990’s, but the HECM took off in popularity in the 2000’s.

The concept was a public private partnership, where FHA would insure the lender against any potential losses, and private lenders would offer the product to the consumer. The FHA, which is a branch of the Department of Housing and Urban Development (HUD), sets some of the parameters of the loan. While they have control over a good portion of it, other changes to the program require an act of Congress.

Let's review the details

Minimum Age

To qualify for a HECM, one of the borrowers must be 62 years of age at the time of closing. That is a statutory requirement and there are unfortunately not any exceptions to it. If two people on title to the home are both 62 or older, both will be borrowers, whether married or otherwise. The younger age is used for life expectancy purposes and to set the loan amount.

If there is a younger spouse living in the home, that person is considered a non-borrowing spouse. Non-borrowing spouses can defer the loan balance for their life in the home if they meet the requirements to do so.

Eligible Property Types

The property types that are eligible for a HECM are a single family residence (SFR), townhome, condo (with restrictions), manufactured home (with restrictions), and 2-4 unit property. No matter the property type, the home must be owner occupied.

Condos must be FHA-approved, either on a complex level, or via the single-unit approval process. Read here for more. Manufactured homes must be on owned land (no rental communities) and be built after 1976.The MFH must have been placed on one property only and has to be taken off the tongue & axle. Co-ops are not presently eligible for a HECM.

Interest Rates

HECM interest rates are primarily adjustable rate, much like a home equity line of credit (HELOC) that you would get from a bank. These loans are based on the treasury index instead of the prime index that is used for HELOCs. Fixed rate loans are available, but are used very infrequently, for a number of reasons. There is no interest rate locking in the reverse mortgage industry.

We do not post interest rates on our website because they change every Tuesday and are also impacted by secondary market forces that can change daily. When we send out a proposal, we explain the initial interest rate, expected interest rate, and the cap on the rate.

Loan To Value & Lending Limits

The loan to value (LTV) ratio is set by HUD and can change from time to time. The three factors that determine the loan amount are the youngest age of any borrower or non-borrowing spouse, the home’s appraised value, and the expected interest rate. Most HECMs are adjustable rate, so the expected interest rate is a bigger factor than the starting interest rate. Given the importance of the expected interest rate at the time of application, the LTV can be significantly different from one year to the next.

The lending limit that is set by HUD is not really a lending limit. It is more of a maximum home value that lenders can base the LTV off of. It has grown from a high of $362K back in the early 2000’s to a high of over $1M. If the lending limit is $1M and you have a $5M home, your LTV is based on the $1M lending limit.

All reverse mortgages are non-recourse by nature, so you cannot owe more than the home is worth.

Distribution Options

With adjustable rate reverse mortgages there are a number of ways in which the funds can be drawn. They are lump sum, line of credit, term, and tenure. Lump sums are limited (see upfront draw limitation section below). Term and tenure are monthly payment options. Term has a fixed number of months or a desired monthly payment amount. Tenure is a lifetime (in the home) monthly payment option that is set based on life expectancy. It is not uncommon to see someone use a couple of the payment options like a partial lump sum and a line of credit. Or a partial lump sum and tenure payment.

Fixed rate reverse mortgages require the loan to be paid out as a lump sum, which conflicts with the upfront draw limitations that we describe below. Therefore, you see fixed rates used only in the case of large mortgages being paid off or for a HECM for purchase loan.

Line of Credit Growth & Loan Guarantees

One of the greatest benefits of the HECM is line of credit growth rate, which is compounded monthly at 1/12th of the rate of interest plus ongoing MIP rate. When the interest rate rises, so does the line of credit growth rate. With a 5% growth rate, the line of credit will double in 14 years if left unused. That drops to 10 years if the growth rate reaches 7%.

The line of credit is guaranteed, which is very different from a HELOC. A HELOC can be frozen, reduced, or cancelled at any time, and comes with a teaser payment and then a balloon payment. A reverse mortgage line of credit cannot be frozen, reduced, or cancelled as long as you meet the loan requirements and do not file for bankruptcy. The loan requirements are to live in the property as your primary residence, not vacate it for more than twelve months consecutively, and stay current on the property charges.

Mortgage Insurance Premium (MIP)

All FHA loans, whether reverse mortgage or 30-year fixed, come with an upfront mortgage insurance premium and an ongoing insurance charge. For the reverse mortgage industry, the upfront charge is 2% of the home value, or lending limit, whichever is lower. There have been times in the past when a lower amount was charged with a higher ongoing rate.

The ongoing MIP charge is 0.5% per year, compounded monthly (one twelfth of 0.5%) along with the interest. Larger balances have more mortgage insurance accruing on them than lower ones do.

The concept of the mortgage insurance is to make it safe to lend money with a negative amortization feature. Negative amortization loans have a higher risk of the balance becoming larger than the home value. That is called crossover risk and it is due to compounding interest, home value depreciation, and property deterioration. When the loan balance exceeds the home value upon the sale of the home, FHA makes lenders whole.

Given the crossover risk, lenders have proven when they do not have FHA backing them up, the interest rate is significantly higher. Non-FHA reverse mortgages have come and gone, with multi-year periods of no loans being offered. FHA mortgage insurance charges, while they appear high, serve a purpose.

Upfront Draw Limitation

When you have debt against your home totaling 0% to 50% of the gross loan amount being offered, you can take up to 60% of the loan amount in cash at closing. This is minus any financed closing costs and items required to be paid off at closing, like a mortgage. The remainder is left on a line of credit for 12 months before you have complete access to it.

If you owe 51%-89% of the gross loan amount, you can take 10% of the gross loan amount in cash at closing, with the rest being available on a line of credit after 12 months. If you owe 90% or more, you are able to have a fully drawn reverse mortgage at closing.

There is no requirement to take cash at closing, and you can opt to leave all proceeds on a line of credit. HUD instituted this rule in 2013 to try to slow down the loan from being fully drawn at closing. They created the program with the idea of providing gradual funding over a long period of time vs. providing a lump sum at closing.

The terms are based on current market conditions and your financial situation.

Our expert loan officers are here to assist you with any questions you may have about your unique situation.