If you’re of retirement age and want to supplement your income, you may want to consider a Home Equity Conversion Mortgage (HECM). A HECM is a reverse mortgage through the Federal Housing Authority (FHA) that converts your home’s equity into cash or a line of credit with no monthly payments. Many people also work with a financial advisor to optimize their retirement savings and investments for their needs and goals. Let’s break down how a HECM works, the pros and cons and when it might make sense for your finances.
How a HECM Works
A HECM is a type of reverse mortgage, which means that it’s essentially a loan taken out against the value of your home. A reverse mortgage is a mortgage in reverse. This means that it allows you to take some of the equity you’ve built in your home and convert it into cash or a line of credit without selling your home or accruing additional bills. It’s similar to a home equity loan or home equity line of credit (HELOC).
Reverse mortgages are unique in that you aren’t required to make loan payments. Rather, when you sell your home or pass away, the entire balance of the loan becomes due.
A HECM is the only reverse mortgage insured by the federal government and is only available via a U.S. Department of Housing (HUD)-approved lender. HECM dispersions can be made via a fixed monthly payment or line of credit, or a combination of the two.
A HECM is one of three types of reverse mortgages. The other two are single-purpose reverse mortgages and proprietary reverse mortgages. Single-purpose reverse mortgages are offered by state or local government agencies for a specific purpose. Proprietary reverse mortgages are private loans. Keep in mind, your home is the collateral for the loan if you choose a HECM.
How to Qualify for a HECM
There are several requirements you must first meet in order to qualify for a HECM. The property must be your principal residence and you must:
- Be 62 years or older in age
- Own your property (or have a small mortgage balance)
- Not be delinquent on any federal debt
- Participate in an information session run by a licensed and approved HECM counselor
Your property must also meet several requirements. It must be one of the following:
- A single-family or 2-4 unit home
- A HUD-approved condominium
- A manufactured home that meets FHA requirements
Though not a hard and fast deadline, you’ll generally need to own at least 50% equity in your home to apply for a reverse mortgage. Additionally, the HECM loan limit is capped, which means that you are not necessarily entitled to whatever equity you’ve earned on your home. As of 2021, the HECM mortgage limit is $822,375.
Pros and Cons of HECMs
While reverse mortgages can often be risky since the loan balance must be paid back, they do offer the benefit of turning home equity – commonly older Americans’ main asset – into liquid cash.
Additionally, a HECM can help supplement retirement income of older Americans who are likely living on a fixed income like Social Security, or whose single largest asset is their home. It may be a useful tool for those who are worried about outliving their retirement savings or have nothing saved at all.
As mentioned, a HECM is the only type of reverse mortgage insured by the federal government, which means that it’s a safer option as far as reverse mortgages go. HECMs often come with lower interest rates, too. And since you don’t have to make regular payments on this loan, the risk of default is lower.
Tempted to sign on the dotted line for a HECM? Be mindful – fees to set up a HECM can be high. Perhaps one of the biggest drawbacks though is that the loan amount grows over time due to interest. While you aren’t paying it back in monthly installments, the loan balance is still due at the time you sell your house or pass away. This could complicate things for your budget when you sell, or your heirs when you pass away. Your heirs will be tasked with paying the balance of the HECM upon your death.
A HECM is just one type of reverse mortgage. While it’s not without drawbacks, it can help retirees supplement their income as they age, which could improve their quality of life. However, it’s wise to carefully consider whether a reverse mortgage like a HECM is right for you. After all, the fees may be high and the balance will eventually have to be paid off when you choose to sell your home or pass away. Take the time to weigh all of your retirement income options before choosing the right one for your situation.
Financial Planning Tips
- If you’re in need of financial planning help, it may be wise to work with a financial advisor. Finding a financial advisor near you doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use a retirement calculator to better understand your financial situation. It may help you make changes that could make a big difference in the future.
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