Pros and Cons of a HECM

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Home Equity Conversion Mortgages (HECMs), or government-backed reverse mortgages, can be useful tools for retirement planning, but they don’t make sense for everyone. Potential borrowers should weigh pros like no mortgage payments and aging in place against HECM expenses and the possibility that they won’t be able to pass their home to their children. 

Every borrower has a unique perspective, and what one person considers a con may be a pro to another. For instance, a borrower without children may find the probability that they won’t pass their home to the next generation isn’t an issue. In contrast, that likelihood could be a deal breaker for a borrower with strong family ties. With that caveat in mind, here is a rundown of the general pros and cons of a Home Equity Conversion Mortgage.     

Reverse Mortgage Pros 

HECM borrowers have the financial freedom to use funds as they please without the stress of required monthly mortgage payments.  

Here are some more of the benefits of taking a reverse mortgage:  

Funding Flexibility 

The flexibility to choose how to receive loan proceeds allows borrowers to decide what works best for their financial strategy. Borrowers may receive a lump sum, monthly payments, a line of credit, or a combination of these options. The line of credit option is especially advantageous since it grows over time, giving loan holders more borrowing power in the future.  

Government-Backed   

 HECMs are guaranteed and regulated by Housing and Urban Development (HUD) and are nonrecourse loans. Nonrecourse means that lenders cannot go after other assets to satisfy the loan, even if the home’s value depreciates. Government regulation assures borrowers who remain in good standing on their loan won’t have their attached line of credit reduced or frozen, even if a lender goes out of business. Recent HUD guidelines also allow a qualified non-borrowing spouse to stay in the home if the last borrower moves to a nursing home for more than 12 months or passes away.  

No Mortgage Payments   

Reverse mortgage borrowers often see their monthly cash flow increase because the loan does not require them to make monthly mortgage payments. The mortgage balance, including accrued interest, is paid in full when the loan comes due. Though borrowers do not need to make a mortgage payment, they are still required to pay for other home-related financial obligations, including property taxes, insurance, and HOA dues. 

Age in Place 

People with substantial equity who wish to stay in their homes may find a reverse mortgage offers a mechanism for tapping their equity without downsizing or relocating.  

Tax-Free Proceeds 

The proceeds from a reverse mortgage — whether in a lump sum, a monthly payment, or a line of credit — are not considered income. Since the Internal Revenue Service (IRS) considers these payments loan proceeds, they are not taxed. Reverse mortgage borrowers are still subject to other property-related and income taxes. 

Reverse Mortgage Cons  

With any financial transaction, there can be downsides. For borrowers who want to move frequently, leave their home to their children, or not jeopardize payments from need-based programs like Medicaid, a reverse mortgage may not be a good fit. With a reverse mortgage, a borrower is prevented from deducting interest annually from taxes and can only do so once the loan balance is paid in full.  

Here’s what borrowers need to understand before applying for a HECM.  

Children May Receive a Lesser Inheritance 

Because a reverse mortgage comes due when the last borrower on the loan dies, settling the loan balance falls to the heirs. Because a reverse mortgage is nonrecourse, heirs will never end up owing more than the home’s market value at the time the mortgage comes due. However, children who wish to keep the house must pay the balance and interest in full. If the home’s market value is greater than the amount owed, heirs can sell the home to satisfy the loan balance. Regardless of whether the heirs sell the house themselves or turn it over to the bank to sell, they will always receive any amount of the sale that exceeds the balance. 

No Annual Interest Deduction  

Though reverse mortgage borrowers have interest added to their loan monthly, they are not eligible to deduct this interest on their tax return until the loan comes due. Unlike a conventional mortgage, where borrowers can deduct paid interest from their annual tax return, in a HECM, a single deduction is allowed when the loan is paid in full.  

Costs and Fees 

Although it feels like you’re getting “free” money every month or as a lump sum, the reality is that, like any loan, a HECM will come due. There are fees and costs associated with taking and maintaining the mortgage, including an origination fee (capped at $6,000 by HUD), mortgage insurance premiums, and interest. All these costs and expenses can be rolled into your loan, which means they are subtracted from loan proceeds. 

In addition, to keep the loan in good standing, borrowers must maintain their home and keep up with home insurance, property taxes, maintenance fees, and HOA fees. 

Need-Based Benefit Conflict

 If a borrower receives government benefits like Supplemental Social Security Income (SSI) or Medicaid, receiving proceeds from a HECM may impact those need-based payments. It is a good idea to discuss if receiving HECM proceeds compromises your ability to continue receiving SSI or Medicaid income with a financial planner or attorney.  

Fixed Interest Rate Limitations 

 While many borrowers prefer a fixed interest rate, a HECM with this election is more restricted than variable rate reverse mortgages regarding how much a borrower can take and in what form. Fixed-rate reverse mortgages do not have the same flexible payment options as variable-rate reverse mortgages. Fixed-rate borrowers can only take a single lump sum payment. Additionally, HUD’s 60% utilization rule says that a reverse borrower can only take 60% of their eligible funds in the first year of the mortgage. Because the fixed rate reverse is limited to a single payment, proceeds will only be a percentage of what would be available at a variable rate.    

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