Seniors who are “house rich, cash poor” may be lured in by television ads promising to give you cash for the equity in your home. They make it sound so easy and they make it sound as though there are no strings attached. While it is true Home Equity Conversion Mortgages (HECMs) are backed by the federal government, there are plenty of details to consider, including some changes recently made to the HECM loan product.
The government has been losing money on some types of HECMs. To fix that, they made some changes designed to prevent further losses. Here is an outline of Home Equity Conversion Mortgages as they operate under the new rules.
HECM Saver versus HECM Standard
Which is a better option for you?
To qualify for a HECM, homeowners must be 62 or older, own their home free and clear, or have a low forward mortgage balance that can be paid off with proceeds from the HECM.
There are two types of FHA backed, Home Equity Conversion Mortgages (HECMs): HECM Standard and HECM Saver.
You will need to decide if a HECM of any type is right for you, and if it is, then which type of HECM is best for your situation.
Consider the difference between the Standard and the Saver:
A HECM Standard will generate more money for you, but it will cost more than a HECM Saver.
- Also, a HECM Standard only comes with an adjustable rate.
- A HECM Saver will generate less money for you, but it will cost less AND you can choose a fixed interest rate or adjustable rate.
Adjustable Rate Comparisons
If you choose the HECM Standard, you will have to choose what type of adjustable interest rate you want.
If you choose a HECM Saver, you can get a fixed rate or an adjustable rate.
There are two adjustable rates to choose from:
- Monthly adjustable
- Annually adjustable
Here is a comparison of these two types of adjustable rates:
Monthly adjustable rates are the most volatile, but are nearly always the lowest available rate.
- Monthly adjustable will change more often and potentially more dramatically over the life of the loan.
- The monthly adjustable interest rate can change as much as 10%. It won’t ever change more than 10% over the life of the loan, but it could jump 10% in a single month, then stay at that higher rate for the remaining life of the loan.
- It is unlikely to change this much in a single month because rates don’t typically change so quickly and so dramatically. But it is theoretically possible, and should be considered.
Annually adjustable rates are usually higher than the monthly adjustable rate, but they are less volatile.
- Annually adjustable rates may change only once per year.
- Annually adjustable rates may change no more than 5% over the life of the loan.
- Annually adjustable rates may rise or fall no more than 2% per year.
- If you anticipate sharp increases in interest rates in the coming years, and you are concerned about preserving equity for the future, you may want to consider the annually adjustable rate.
- If you are not worried about sharp increases in interest rates, and you want to maximize the funds available immediately after closing, you may want to select the monthly adjustable rate option.
Consider the Numbers
Mortgage Insurance Premium (MIP) This acts like gap insurance, so if the loan balance ever surpasses the property’s value, then the MIP will cover the difference, which protects you, your heirs and the bank. In short, when the loan comes due, the MIP will pay the difference between the home’s value and loan balance. If the home’s value is more than the loan balance, then you or your heirs keep the remaining equity.
The loan comes due when the last remaining borrower moves, sells or dies. If the property is worth $100,000 but the loan balance is $125,000, then the MIP will pay the deficiency balance of $25,000.
The cost of the MIP is paid by the lender and that cost is added to your loan balance. The MIP must be renewed each year, with the cost to renew it being added to your loan balance. Interest and other fees are also added to the loan balance, which means it is theoretically possible that your loan balance could grow and grow to a point where the loan balance exceeds the home’s value (particularly if the home’s value drops). Again, the MIP comes to the rescue in this situation and picks up the tab for the difference between the property value and loan balance.
With a HECM Saver, the upfront Mortgage Insurance Premium (MIP) will equal 1% of the property’s value.
With the HECM Standard, the upfront premium is 2% of the property’s value.
The MIP for both HECM Saver and HECM Standard will be charged monthly at an annual rate of 1.25 percent of the outstanding loan balance.
Borrowers may receive approximately 10% to 18% less under the HECM Saver option, than they would receive under HECM Standard.
HECM borrowers may opt to receive funds as a lump sum at loan origination, establish a line of credit or request fixed monthly payments that are disbursed for as long as they continue to live in the home.
Funds are advanced to the borrower and interest accrues, but the outstanding amount does not have to be repaid until the last surviving borrower dies, leaves the home or sells the property. At that time, if the balance due on the loan exceeds the value of the home, FHA insurance (the MIP) pays the difference.
The HECM is not assumable, so if heirs wish to keep the property once the borrower(s) move or die, then the heirs will have to satisfy the HECM loan by paying either the loan balance, or 95% of the property’s value, whichever is the lower amount. Otherwise, the home will be sold on the open market for fair market value. If the home is sold for more than the loan balance, then the remaining equity is sent back to the estate.
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