Educational Module-4: The Home Equity Conversion Mortgage (HECM)

The Home Equity Conversion Mortgage (HECM)

As indicated in the History Module, the many negative aspects and flaws of the previous versions of Reverse Mortgages compelled the Government and the industry to fix these loan products to protect senior borrowers.

Inputs from industry and academic participants and especially from the HUD and FHA, where they donated mortgage loan components and guidelines, clearly defined, standardized and stabilized the Reverse Mortgage market via the new and somewhat revolutionary Home Equity Conversion Mortgage (HECM) loan program.

(Note that this Module is a bit longer as the HECM loan is the keystone of the Reverse Mortgage industry).

The new HECM loan features included:

Controlling aggressive marketing and sales behavior: HUD adapted their existing "counseling" for HECM loans for use by their approved counseling agencies. This provided a third-party review, along with the borrowers, of the proposed HECM loan provisions to determine the prospective borrower's understanding of and need for the loan. The counseling step is mandatory and MUST be completed before the RMLO can formally take the loan application and initiate a loan. This simple step created an arm's length distance and cooling off period from overly aggressive marketing and sale behavior.

Create borrower's ability to back out of the loan: By using the HUD/FHA standard "three-day right of rescission" regulation, the borrower can cancel the HECM loan, within three business days of signing, without penalty, which gives the borrower time to review their decision. This also provides added to the protection from overly aggressive marketing and sale behavior.

Reduce and control the perceived expensive loan costs: HECM loans have a fixed origination fee, which compensates the lender/RMLO and is capped at $6,000. It is calculated as the greater of $2,500 or 2% of the first $200,000 of the amount of the loan for which the borrower is qualified, plus 1% of any amount exceeding $200,000 up to the maximum compensation of $6,000. In addition, the early loans were perceived as higher risk by the lenders thus the interest rates were higher.

Reduce the concern of running out of equity: With the traditional 80%/20% residential loan format, when used for Reverse Mortgages, many times the 20% equity was quickly exceeded by the interest being added to the loan's balance. This was creatively addressed by a new formula based on life expectancy tables and a newly created uniform equity conversation table based on the borrower's age and the current interest rate. This increased the equity available for the loan to 40% or below. The table's use is mandatory for all HECM lenders. This, along with a built-in home appreciation factor of 4.00% per year nationwide, greatly extended the timeline and safety for the conversion of the available equity,

Eliminate the Borrower's risk of the mortgage loan balance being greater than the home's value: Using the FHA mortgage insurance (Mortgage Insurance Premium - MIP) provided a safety net for the borrowers, where they are not financially liable if their home's value is less than the loan balance, which created a "non-recourse" loan for the borrowers,

Remove the lender control of the home via the HECM loan: Specifically, for HECM loans, the borrower, not the lender, retains control of their home such that they, or their estate, can decide its disposition at the end of the HECM loan "contract" and retain any available equity. This eliminated the traditional foreclosure incentive by the lender.

Creating a variety of formats for the borrower to convert their home's equity: The following payment options are available for adjustable-interest rate HECM loans:

• Tenure: equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence,
• Term: equal monthly payments for a fixed period of months selected,
• Line of Credit: unscheduled withdraws, at times and in an amount of the borrower's choosing until the line of credit is exhausted,
• Modified Tenure: combination of line of credit and scheduled monthly payments for as long as the borrower remains in the home,
• Modified Term: combination of line of credit plus monthly payments for a fixed period of months selected by the borrower.

For fixed-interest rate HECM loans, the borrower receives the Single Disbursement Lump Sum payment of the available equity when the loan closes.

Defining who can borrow: For HECM loans, the borrower has to be 62 years of age to even apply for a HECM loan (interesting that age 62 is the first year of Social Security eligibility which usually means the borrower is "retired" – hence the HECM loan has been referred to as the "retirement mortgage").

Defining the maximum loan amount that can be borrowed: The amount is based on

• The age of the youngest borrower or eligible non-borrowing spouse/person on title,
• Current interest rate (the Index plus the Margin),
• Lesser of the appraised value or the current HECM FHA 2025 mortgage limit of $1,209,750.00. Recall that in the Ecosystem Module that HUD/FHA sets the FHA "insured" lending limit for each county in the United States. For all HECM loans, regardless of the county, the current highest amount for the entire United States is used.

Defining the qualified property: Using FHA guidelines, HECM loans are for single family residences (SFRs), 2-to-4-unit residences with one unit occupied by the borrower, HUD-approved condominium projects, and manufactured homes that meet FHA requirements, where the subject property is the borrower's primary residence

Defining more appropriate terminology for HECM loans: As the format and calculation for HECM loans differ from traditional mortgage loans, the usual Loan-To-Value (LTV) is replaced with the Principal Limit Factor (PLF), which is the percentage (%) of equity available to be distributed. The PLF is multiplied against the property value from the appraisal, and the result is the Principal Limit (PL). Then all loan costs (any existing mortgages or mandatory liens, compensation, title, escrow and closing costs, etc.) are deducted from the PL to calculate the Available Funds, to be distributed as per the borrower's instructions.

Defining the end of the HECM loan's term and "contract": The term for HECM loans is up to the borrower's age of 150 (yes, 150 - hence the HECM loan has been referred to as "the lifetime mortgage").

The HECM "contract" ends with:

• The sale of the property,
• The last remaining borrower dies or is out of the property for 12 consecutive months (usually in a care facility, etc.),
• The borrower is delinquent with, one or more of, the property tax, hazard insurance, HOA dues (if applicable) and routine property maintenance and does not remedy the issue in a reasonable period of time.

When the contract is ended, the borrower, or their estate (not the lender), has the right to sell the property, purchases the property for 95% of the current appraised value or, in rare situations, let the lender take title to the property (with any excess equity being returned to the borrower or their estate).

Help stabilize and encourage HECM lenders: To remove the possibility that the lender would take a loss if the loan's balance exceeded the property's value, the inclusion of the FHA mortgage insurance (MIP) guaranteed to make the lender whole at the end of the "contract",

Help grow HECM market: HUD created a secondary market specifically for HECM loans via the HUD owned and controlled Government National Mortgage Association (GNMA or Ginnie Mae). This is a critical step as the HECM loans do not produce monthly cash-flow for the lenders which usually determines the loan's value and salability.

Since 1989, as the HECM loan's usage increased, areas for improvement appeared, HUD/FHA and the lenders have worked together to ensure the ongoing viability of the program.

HECM to HECM Refinance (2004): A HECM-to-HECM refinance is a simple reset of an existing HECM loan where the previous HECM loan is paid off and a new HECM loan takes its place. The refinance may be to lower the interest rate and/or have more equity available for conversion. Most times there is credit for prior MIP paid on the earlier HECM loan.

HECM for Purchase (2009): With older borrowers downsizing and/or moving closer to family, the HECM guidelines were adjusted to allow HECM loans to be used to purchase a new home. Many of these borrowers use the equity from selling their current home to make the down payment on the new home. Typically, the down payment for a HECM for Purchase loan is between 45-70% of the purchase price. Once in place, all HECM features and benefits are provided to the purchaser/borrower.

The HECM 60% Rule (2013): HUD observed that many HECM borrowers were taking the maximum cash-out and later were not able to pay the ongoing property charges (property tax, hazard insurance, HOA dues where needed and property maintenance). To address this issue, the rules were adjusted to allow borrowers to access up to 60% of the principal limit or mandatory obligations (existing mortgage, closing costs, etc.) plus 10% in the first 12 months with the remaining proceeds being available after 12 months.

Non-Borrowing Spouse/Person on Title (2014): The non-borrowing spouse/person on title is a person who does not qualify for the HECM loan due to age or because the PLF would be higher if they were not on the title of the new HECM loan. The HECM guidelines were adjusted to provide for the non-borrowing spouse/person on title so that they could remain in the home, with certain reduced HECM provisions, until the end of the "contract" was reached.

Financial Assessment (2015): Via the HUD ongoing evaluation of the HECM loan program and its related MIP fund, it was observed that some HECM borrowers were not paying the required obligations (i.e. property tax, hazard insurance, HOA due and maintenance) during the loan which was causing some loans to being in default. The new guidelines required that all financial obligations be balance against the borrower's income and if the income was not sufficient, a Life Expectancy Set-Aside (LESA) amount would be withheld from the HECM loan proceeds for the payment of these charges for the duration of the "contract". Loan term???

The above information provides a general overview of the basic HECM components, features and their content.

As with all residential mortgage programs, including the HECM loan program, HUD, the FHA, lenders and the secondary market have many underwriting guidelines that address every possible circumstance in a borrower's loan file that determine the final eligibility and subsequent structure of each HECM loan.