The Housing and Community Development Act of 1987 authorized the Home Equity Conversion Mortgage Program (HECM) in the Department of Housing and Urban Development (HUD) as a demonstration program. It was the first nationwide reverse mortgage program which offered the possibility of lifetime occupancy to senior homeowners. Such mortgages are referred to as â€œtenureâ€ reverse mortgages. The borrowers must be seniors who own and occupy their homes. The loanâ€™s interest rate may be fixed or adjustable. The homeowner and the lender may agree to share in any future appreciation in property value. The program has been made permanent and the law was amended to permit its use for one to four family residences if the owner occupies one of the units.
The borrower can choose from five payment plans:
- Tenure â€“ equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
- Term â€“ equal monthly payments for a fixed period of months selected by the borrower.
- Line of Credit â€“ installments at times and in amount of borrowerâ€™s choosing until the line of credit is exhausted.
- Modified Tenure â€“ combination of line of credit with monthly payments for as long as the borrower remains in the home.
- Modified Term â€“ combination of line of credit with monthly payments for a fixed period of months selected by the borrower.
The HECM law requires that the loan not exceed the Federal Housing Administration (FHA) mortgage limit for the area in which the property is located. The mortgage must be a first mortgage, which implies that any previous loan be paid off. Prior to obtaining a loan, borrowers must be provided with counseling by third parties who will explain the financial implications of entering into home equity conversion mortgages as well as explain the options, other than home equity conversion mortgages, that may be available to senior homeowners. To prevent displacement of senior homeowners, HECMs must include terms that give the homeowner the option of deferring repayment of the loan until the death of homeowner, the voluntary sale of the home, or the occurrence of some other events as prescribed in HUD regulations. The borrower may repay the loan without penalty.
Borrowers are required to purchase insurance from FHA. The insurance serves two purposes: 1) it protects lenders from suffering losses if the final loan balance exceeds the proceeds from the sale of a home, and 2) it continues monthly payments to the homeowner if the lender defaults on the loan. At loan origination borrowers are required to pay an up-front mortgage insurance premium (MIP) of 2% of the maximum mortgage amount. In addition, borrowers pay an annual insurance premium of 0.5% of the loan balance. Borrowers do not directly pay the insurance premiums. Lenders make the payments to FHA on behalf of the borrowers with the cost added to the loan balance.
When the home is eventually sold, HUD will pay the lender the difference between the loan balance and sales price if the sales price is the lesser of the two. The claim paid to the lender may not exce3ed the lesser of 1) the appraised value of the property when the loan was originated, or 2) the maximum HUD-insured loan for the area.
This post was written with text from the Congressional Research Service report â€œReverse Mortgages: Background and Issues, April 8, 2008.â€