A HECM reverse mortgage isn’t going to be the best option for everyone, but increasingly more seniors are discovering the many advantages of this relatively new type of loan. Knowing what each type of loan offers (and doesn’t) is key in choosing which one would be your best option.
Traditional, sometime called ‘forward’, mortgages and home equity loans have been around for centuries. A lender gives a borrower money to either buy a house or as refinancing on their existing home. The lender keeps the deeds as a guarantee until all the capital plus interest is paid back. With each monthly repayment, the borrower takes one step closer to owning their home and with each payment, the loan amount decreases and the equity in their home increases. However, the borrower risks loosing all the money paid money and their home should they fail to make the monthly repayments.
A HECM reverse mortgage is regulated and insured by the U.S. government. It’s called ‘reverse’ because the lender agrees to give the borrower money based on the equity they have in their home. The borrower must own outright (or almost outright) their home and as such will be in possession of the title deeds. But, unlike a tradition mortgage, the deeds stay with the borrower and never the lender.
What also differentiates this loan type is that, although the lender gives the borrower money, the borrower does not have to make monthly repayments. Instead, the capital plus interest is paid back as one lump sum but only when the home no longer is the borrower’s primary residence, the borrower sells it or the borrower dies. The borrower can never loose their home as there are no monthly repayments.
Many seniors find themselves, for many reasons, needing extra cash. Until recently, they had 2 options, either sell their home and rent or buy somewhere cheaper or to refinance using a traditional mortgage or home equity loan.
The biggest problems with getting a traditional mortgage or home equity loan is that the lender requires proof of income (usually pension or stock portfolio etc.), health and credit checks. Also, because of the borrower’s age, the time span of the loan repayment plan would be shorter rather than longer, leading to hefty monthly repayments. Finally, failing to keep up with the repayments would result in the borrower loosing their home.
The advantage of this traditional loan is that as the loan is paid back the equity is put back into the home. Also, the borrower gets insurance so that, in the event of their death or illness, the loan will be paid in full, leaving the home debt free. Those who inherit would do so without any debt still outstanding on the home.
The advantages of a HECM reverse mortgage are that the lender needs no such proof of income or health checks. Being older is also an advantage as the amounts that can be borrowed are larger. The borrower can remain living in their home for the rest of their life without fear of loosing it.
The biggest disadvantage is that the loan must be paid back when the borrower vacates or sells the home or dies. This means that there could be very little equity left in the home or even none at all. Although heirs are not forced to sell the home, they must pay the debt somehow and most do so by selling the home. Note: the amount borrowed can never exceed the equity in the home (FHA insurance guarantees this), so there’s no worry about heirs being stuck with debts with they sell it.
Ultimately, whether or not a HECM reverse mortgage is your best option is something you can only decide upon after speaking with your family, partner and your local broker. Counseling is also mandatory before you can take out the loan.