How does a HECM work?

A lender will appraise your residence. The value that will be used will be the lesser of the sales price (if being purchased), $636,150 (the Federal Loan Limit) or its actual appraised value. It must be your primary residence.

Based on the age of the youngest borrower aged 62 or older on title (or if a spouse not on title, and younger than 62, then we use his/her age), the lender calculates the estimated remaining years the borrower(s) might remain in the home.

Using this period of time estimate, the lender calculates the amount of money to be made available to the borrower(s) using either (a) for a Fixed Rate HECM, the actual fixed interest rate chosen on the HECM, or (b) for a Variable Rate HECM, the actual margin selected added to the 10 Year LIBOR swap Interest Rate, so that when all the mortgage interest and MIP (of annual 0.50%) is added to the money borrowed over the years estimated, the total will equal the original appraised value, plus (in some cases and options) some small estimate for the increasing real estate value over time. Note that the interest rates used here are what we call the FHA Expected Rate, and NOT necessarily what you might be charged on the loan, through time. This Expected Rate is FHA’s best estimate of interest cost over life of loan (using 10 years in the future as an estimate, or just the fixed rate, since this rate cannot change).

Let’s make a simple example. Assume the youngest borrower is aged 75. And the house is worth $400,000. According to the FHA, assuming an interest rate of 4.5% qualifying (or FHA Expected Rate)  at 75 years of age, the estimated remaining life of a person is 12 years. Per the FHA the borrowers get 51.9% (based on October 2nd, 2017 tables) of that appraised value, or $207,600.

If the borrower were 90 years old, FHA would permit a 67.2% advance of the $400,000 appraised value. Why? Because a person aged 90 has a smaller remaining expected life and will, therefore, use less of the home value in accruing unpaid interest and MIP. So, more of the home value is available to older borrowers.

Borrower(s) do not have to repay the HECM during their lifetime. They can opt not to make any repayments, and let their heirs (if there is remaining equity in the home), or the lender (if no equity left) sell the home to fully satisfy the HECM. But they must pay the home’s taxes and insurance and make mandatory repairs while they occupy the home. If they do not, they face foreclosure.

If the HECM you took is a variable rate open-end credit (like a Home Equity Line of Credit (HELOC)), any repayments a borrower makes against the outstanding balance may be re-borrowed. And if you make partial or full repayments on any HECM, there are no prepayment penalties.

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