I thought I would begin this article with a pun about flexibility but decided not to because it would be too much of a stretch.
As I get older, I realize more and more how important it is to stay flexible, physically, financially, mentally and emotionally. Unfortunately, it takes a lot of effort to keep this mindset. I wish I was more like the Home Equity Conversion Mortgage (HECM) because flexibility is built in with this dynamic, 34 year old program.
The HECM is the FHA insured reverse mortgage program that is specifically designed for homeowner’s aged 62 and above, that allows you to convert a portion of the value of your home into money, without having to sell the home, give up title or obligate yourself to a monthly mortgage payment. Since the home stays in your name, it is still your responsibility to pay your homeowners insurance and property taxes, as well as maintain the home and live their as your primary residence.
The HECM has been around since 1989 and has a number of different ways for you to convert a portion of the illiquid equity you have built up in your home into spendable funds. This article will explain the different ways you can receive funds from the HECM reverse mortgage program.
First, I need to explain that FHA dictates to the lender how much they are allowed to loan. There is no set “loan-to-value” like there is with a forward mortgage. It is different for every borrower based on three things:
- Age of the youngest borrower (or non-borrowing spouse)
- Value of the home
- Interest rate*
Generally speaking, the higher the interest rate, and the younger the borrower (or non-borrowing spouse), the less money you can receive as a percentage of the value of the home. The lower the rate, the older the borrower (or non-borrowing spouse), the more money you can receive.
Having said this, given the interest rates as of today, January 2023, most borrowers are able to access between 35%-55% of the value of the home. Any existing loans against the home need to be paid in full from the loan proceeds. Whatever funds available after this are the borrowers to do with as they wish.
For example, if your home is valued at $500,000 and you are 68 years old, you could receive about $183,000 after closing costs. If you have an existing mortgage balance of $180,000, this will have to be paid first and then you would receive the $3,000 that is left.
People often ask, “If I am only getting $3,000 from this loan, why would I do it?” The reason is because you would be eliminating the principal and interest portion of your mortgage payment. If your principal and interest equal $1,200 per month, and you took out a HECM to pay this loan off, you would no longer have this expense in your monthly budget. In this case, your biggest benefit would be saving $1,200 per month.
If you happen to own a $500,000 home outright (with no loans against it), you have a lot more options in the way you receive the funds.
- A lump sum (with some FHA restrictions)**
- A monthly payment guaranteed to last as long as you or your spouse live in the home
- A monthly payment over a specified time period
- A Line of credit
- Any combination of the above
You can also change any of these plans after the loan is in place. For example, let’s say you decide to set a monthly payment to you of $500 per month with a line of credit of 50,000, but a year later your situation changes, and you now need $700 per month. You can increase your payment and reduce your line of credit. Or if you do not want to reduce the line of credit, you can shorten the term of the monthly payment. There is just a one-time $20 fee to make any changes after the loan is closed.
Think of the HECM like buckets of money. You have in this case, $183,000. If you want a monthly payment of $500 per month, we have to take a portion of the $183,000 and set it aside to send you that money every month for however long you request it. If you want $20,000 at the closing, we have to take it away from the original $183,000 to give to you. Everyone has different ages, different values and different interest rates. Because this loan doesn’t have a set amount we loan to everyone, it is truly a personalized loan and we can customize it to fit your needs.
This is why I say the HECM is so flexible. We can pull, twist and shape it to your individual financial needs.
*There are two different interest rates with the HECM program. One is called the “initial rate”. This is the rate the borrowers are actually charged on the outstanding loan balance once the loan closes. This rate is calculated but taking the one-year treasury index and adding the margin to it. The lender decides the margin. For example, if the one-year treasury index.
**FHA restricts the amount you take from the HECM during the first 12 months of the loan to 60% of the amount available (principal limit), unless the liens against the home exceed this cap. If the outstanding liens on the home exceed 60% of the principal limit, FHA allows you to take enough out to pay them off, plus an additional 10% of the principal limit.