Understanding the types of reverse mortgages
An HECM reverse mortgage is a type of home equity loan that allows certain homeowners to convert their home equity into cash. It is different than a traditional home equity loan in that the owner does not make monthly payments to repay the loan. Instead, a reverse mortgage loan is repaid, with interest, when the property is sold, refinanced, or when the homeowner moves out of the house.
Reverse mortgages come in three types, each serving different needs.
Home Equity Conversion Mortgages
The most common reverse mortgages are Home Equity Conversion Mortgages (HECMs). These are federally insured loans backed by the U.S. Department of Housing and Urban Development (HUD).
HECMs are used by seniors who want to convert part of their home’s value into cash. The proceeds can be used for any reason, such as covering monthly expenses, paying long-term care insurance premiums, or maintaining a line of credit in case of large health expenses or other non-budgeted needs.
Before receiving an HECM, a homeowner is required to meet with a counselor from an independent, government-approved housing counseling agency. The counselor will explain the cost of the loan and other financial implications, as well as alternatives to an HECM.
Since homeowners are still required to pay utilities, property taxes, and insurance, the lender must also conduct a financial assessment to evaluate the borrower’s willingness and ability to meet these obligations. The lender may require funds to be set aside from the loan proceeds to pay these expenses.
The amount a homeowner can borrow will depend on the age of the youngest borrower, current interest rates, and the property’s appraised value, up to a cap of $625,500.
HECMs offer several payment options, including:
¥ A single disbursement, which typically offers less money than the remaining options and is only offered with a fixed interest rate.
¥ A term option, which provides fixed monthly payments for a specific period.
¥ A tenure option, which provides fixed monthly payments for as long as you live in the home.
¥ A line of credit that allows you to draw down the loan proceeds at any time, in amounts you choose, until you have used up the line of credit.
¥ A combination of monthly payments and a line of credit.
One of the major restrictions on HECMs is how much money a borrower can receive up front, called the “initial principal limit.” This limit will be based on age, the interest rate, the value of the home and the borrower’s financial assessment. Typically, an HECM will limit the upfront amount to 60 percent of the overall loan amount.
Single-purpose reverse mortgages
Single-purpose reverse mortgages are loans available to homeowners to address a single expense, such as home repairs or property taxes. The lender restricts how the lender can use the borrowed funds, and typically will only loan a small amount of the property’s equity. This type of reverse mortgage is offered by government and non-profit agencies and are typically available to low and moderate-income homeowners.
Single-purpose reverse mortgages are not federally insured, which saves on the cost. The lack of insurance doesn’t impact the borrower, other than the cost savings, because the insurance serves to protect the lender against default.
Proprietary reverse mortgages
Proprietary reverse mortgages are offered by private lenders, and are not federally insured. This type of loan is generally less restrictive than HECMs and single-purpose loans but are rare in today’s market.
First, proprietary reverse mortgages do not have a cap. You can borrow as much as a lender will offer up to the full appraised value of the home, even if the property has a value in the millions of dollars. Sometimes referred to as “jumbo” reverse mortgages, these loans are typically used by homeowners with property values that exceed the HECM cap, allowing them to borrow more money (jumbo private reverse mortgage loans).
Proprietary reverse mortgages also do not restrict the amount borrowers can receive in the first year of the mortgage term. Borrowers can usually obtain all the loan proceeds up front.
Another difference between this type of reverse mortgage and an HECM is proprietary loans do not require counseling. Funds form a proprietary reverse mortgages can use the funds for any purpose; there are no restrictions like those on single-purpose reverse mortgages.
Some proprietary reverse mortgages offer an equity sharing provision, which allows the borrower to pay part of the loan balance by passing along a portion of the increased value of the property. In return, the lender will charge an interest rate below the prevailing market rate.
This type of reverse mortgage is not widely available, and there are several fees and contract provisions involved so that this option won’t work for many potential borrowers.