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How Do HECM Reverse Mortgages Differ From Standard Mortgages?
How Do HECM Reverse Mortgages Differ From Standard Mortgages?
Characteristic HECM Reverse Mortgage Standard Mortgage
Purpose Provide spendable funds to existing homeowner of advanced age Facilitate purchase of a house
Eligibility Requirements 1. Minimum age
2. Equity in owner-occupied home
1. Capacity to make required payment
2. Acceptable credit record
3. Adequate down payment
Lender Protection Property collateral only Borrower’s ability/willingness to repay
Property collateral as backup
Loan Amount Determinants Amount of equity in the property Borrower’s age Property value
Borrower’s income
Borrower’s credit
Borrower’s financial assets
Payout of Funds 1. Cash withdrawal at outset, and/or
2. Monthly payment, and/or
3. Future draws under credit line
Withdrawal at outset used for home purchase
Repayment Requirements No periodic payments required
Balance due on death of borrower or permanent move-out
Monthly periodic payments usually required
Payments of balance outstanding (“balloon”) may be required
Debt Changes Over Time Rises over time as interest accrues Declines over time from principal payments

Purpose: The major purpose of a standard mortgage is to facilitate the purchase of a house, or to refinance a mortgage that had been taken out earlier for that purpose.

A reverse mortgage is designed to provide an elderly homeowner with spendable funds that can be used for a variety of purposes, including home purchase. More commonly, the funds are borrowed against a home the senior already owns and occupies as a permanent residence, and used in many different ways.

Eligibility Requirements: To obtain a standard mortgage, borrowers usually must demonstrate that they have sufficient income to make the required payments, that their credit rating is good enough to meet lender requirements, and that they have enough financial assets to cover the down payment and settlement costs.

On a reverse mortgage, borrowers must be 62 or older, and have significant equity in either a home that is their permanent residence, or one they plan to purchase using the reverse mortgage. The house must be single family, in a 2-to4 family structure, in an FHA-approved condominium, or an approved manufactured home. If they have an existing mortgage, it must be paid off with proceeds from the HECM.

There are no income or credit requirements, although that could change early in 2014 when HUD introduces some new rules.

Lender Protection: On a standard mortgage, lenders look to the borrower to repay the loan, and view the property collateral as their last resort in the event the borrower defaults.

On a reverse mortgage, lenders depend wholly on proceeds from eventual sale of the property to be repaid. If the debt balance grows to exceed the property value, the lender will suffer loss, though on HECM reverse mortgages the FHA will assume all or most of it.

Factors Affecting the Loan Amount: On a standard mortgage, the amount that a home purchaser can borrow depends on the value of the property, and on the borrower’s income and available assets.

On a reverse mortgage, the amount a borrower can draw depends on his age and his equity in the home. In both cases, there may be legal and/or regulatory limits imposed on loan amounts.

Payout of Funds: On a standard mortgage, the entire loan amount is disbursed at the outset, as part of a sales transaction or a refinance.

On a reverse mortgage, the homeowner may receive funds in a variety of ways: as a lump sum at the outset, as a monthly annuity paid until death or move-out, as a monthly annuity paid over a specified period, or as a credit line on which the homeowner can draw at her own discretion.

Repayment Requirements: Standard mortgages usually require periodic payments that reduce the balance, or at least cover the interest. Most are fully amortizing, meaning that the payments reduce the balance to zero over the term of the loan. Those that are not fully amortizing require that the balance be repaid in full at the end of the term, called a “balloon”, or after a specified period.

Reverse mortgages, in contrast, have no required payments.

Debt Changes Over Time: On standard mortgages that require amortization, the debt outstanding gradually declines over time. On those that require only interest payments, the balance is constant until the date when fully amortizing payments begin, at which point the balance begins to decline. Standard mortgages on which the balance rises, referred to as “negative amortization loans”, disappeared after the financial crisis.

On reverse mortgages, in contrast, debt tends to rise over time as interest accrues, since there are no required payments. Borrowers may make voluntary payments to reduce their debt, but this is uncommon.