The HECM program is offered by the Federal Housing Administration (FHA), a division of the Department of Housing and Urban Development, and all HECM mortgages are FHA insured. This is by far the largest of the reverse mortgage programs, and has experienced very robust growth. In fiscal year 2003, there were only 18,097 reverse mortgage loans endorsed. This number doubled to 37,829 loans in fiscal year 2004, then increased rapidly to 43,131 in fiscal year 2005, and 76,351 in fiscal year 2006. In the first nine months of fiscal year 2007, 80,425 reverse mortgage loans were endorsed—more than for the entire year 2006.

To be eligible for an HECM loan, a borrower must be aged 62 or over and live in the home as a principal residence. Empirically, we find that most of the borrowers that take out HECM loans are considerably older than the minimum age. In fact, HUD reports that the median age of an HECM borrower was 75; the median age of all elderly homeowners is 72. The home must be a single-family residence in a one- to four-unit dwelling, a condominium, or part of a planned unit development (PUD). Some manufactured housing is eligible. The overwhelming majority (approximately 85%) of these are single-family properties.

Payment Options

An HECM mortgage can be taken out in any of the following forms:

In practice, the line of credit is the most popular option. If a borrower wants to take out money immediately (to pay off a first lien, or take a vacation) it is considered to be a drawdown on the line of credit. In our simplified example in Table 19.1, we wanted to show deterministically how the reverse mortgage would impact the estate. Thus, we included only two options: a line of credit in which the amount was drawn down immediately, and a modified tenure, in which the up-front payment was used to pay off the first lien. In reality, borrowers have far more flexibility than we indicated in our example.

Under the conditions of a reverse mortgage, when the house is sold or no longer used a primary residence, the borrower or their heirs will repay the drawn portion of the credit line (or monthly payments) plus interest to the lender. The remaining value of the house belongs to the estate. It is possible that home price appreciation might be low enough, and the borrower might live long enough, that the price of the house is less than the accreted value of the outstanding loans. For example, assume in Table 19.1 that our 75-year-old borrower selected option 2, receiving a $50,000 up-front payment to cover the first lien, and additional payments of $668 per month. If that borrower died at 90, $346,937 ($137,947 from the up-front loan and $208,990 from the monthly payments) would be owed. If the house value had appreciated 2% per annum (rather than the 5% we assumed in Table 19.1), the appreciated house value would be $336,467, or approximately $10,500 less than the amount due on the reverse mortgage. From on investor's point of view, this is not an issue: Government insurance would cover this, as the loans are FHA insured. From a borrower's point of view, it is also not a concern, as the loans are nonrecourse.

The interest rate on the HECM loan is generally reset either monthly or annually, based on the following reset formula: one-year CMT + a margin, where CMT is the constant maturity Treasury.

In addition to the interest expense, the borrower must pay a mortgage insurance premium (MIP) for the FHA insurance. This premium is equal to 2% of the up-front amount plus an annual premium equal to 0.5% of the loan amount. The MIP is meant to guarantee that if the loan servicer goes bankrupt, the government will step in and make future payments. The MIP also guarantees that if there is any shortfall between sales price and repayment amount, the government will make up the difference. In addition to the MIP, reverse mortgages also carry application fees, origination fees, and often a monthly servicing fee. These charges are generally paid by the reverse mortgage, and the costs are added to the principal and paid at the end, when the loan is due.

Amount that Can Be Borrowed

The amount that can be borrowed depends on a borrower's age, the current interest rate, and the appraised value of the home. Moreover, the maximum size of an HECM mortgage will depend on the maximum HUD loan limit. This varies by county and is adjusted annually. Currently, the maximum is $362,790 for single-family homes in high-cost areas and $200,160 for rural areas. That is, the limit in high-cost areas is 87% of the conventional limit of $417,000. It is 48% of the conventional limit in low-cost areas. The implications of these limits are clear—if two borrowers of the same age applied for a loan at the same time, one with a home value of $362,790 and another with a home value of $1 million, they would both receive exactly the same HECM loan. When there is more than one borrower, the loan amount in an HECM mortgage is determined solely by the age of the younger borrower.

Table 19.2 illustrates the amount that can be drawn out under the HECM program. These calculations assume the home is located in a high-cost area. Thus, if a home were appraised for $250,000, the top section of Table 19.2 indicates a 65-year-old borrower would have a credit line available for $116,568; the credit line would be $144,590 if the borrower were 75, and $174,894 if the borrower were 85. Similarly, if the tenure option were selected, a 65-year-old borrower would receive $744/month, a 75-year-old borrower would receive $1,021/month, and an 85-year-old borrower would receive $1,568/month. If the home appraised for $1 million, the FHA loan limits would be binding, limiting the amount the borrower could receive. Thus, as indicated in the bottom section of Table 19.2 a 65-year-old borrower would have a credit line of $172,286, which is only 46% higher than that available on a $250,000 home.

Table 19.2. HECM Reverse Mortgage Options

The Fannie Mae Home Keeper mortgage program is Fannie Mae's conventional market alternative to the HECM product. It works much like an HECM; the borrower can receive fixed monthly payment for life (that is, for as long as the borrower occupies the home as his/her principal residence), a line of credit, or any combination of monthly payments or a line of credit. However, the Fannie Mae Home Keeper can be used for a broader array of alternatives, including condominiums that are not FHA-approved and new home purchases. The latter is particularly important, as HECM Mortgages require that borrowers have been in their home for at least a year. Let us assume a 75-year-old man wants to sell his home in Philadelphia, with a value of $150,000, and buy a $200,000 home in Florida. To avoid a mortgage payment on the new home (as the borrower's income is very limited), the borrower would have to use the entire $150,000 proceeds from the sale of the Philadelphia home, plus another $50,000 in savings. If the borrower does not have the $50,000, he could not buy the new home (unless he qualifies for and is able to obtain a regular mortgage). But the borrower could seek an FMHK reverse mortgage, which can be used to bridge the $50,000 difference.

Note that even though the loan limits are higher for Fannie Mae programs than the FHA programs, the amount that can be drawn out under the Fannie Mae Home Keeper program is usually less than what can be drawn out under the HECM program. This is illustrated in Table 19.3. A 65-year-old borrower with a home worth $250,000 could draw out $116,568 under the HECM program, while the Fannie Mae Home Keeper would allow only $42,817.

The interest rate on the Home Keeper mortgage is determined as a spread above an index rate—the current weekly average of the one-month secondary market CD rate, which is published by the Federal Reserve. The rate on the Fannie Mae Home Keeper mortgages adjusts monthly.

There are a number of lenders that offer proprietary mortgage products. As on the HECM and FMHK products, the interest rates are variable. These proprietary products generally build in additional protections to make sure the accreted value of the loans will not be higher than the home value. First, these proprietary products do not have a tenure option, as the lenders are unwilling to absorb the risk that the borrower will live long enough that total payments may be higher than the value of the house. Second, the growth rate on the line of credit may be freely altered by the lender. These protections are important to the investor, as there is no government guarantee on these loans.

Table 19.3. Program Comparison

From the borrower's perspective, the big advantage of the proprietary products is that they do not have a loan limit. Thus, for a home with a high appraised value, the borrower is often better off with a proprietary product. This can be seen in Table 19.7, which compares the HECM product with a proprietary reverse mortgage offering from one major originator of reverse mortgages. Note that for a home valued at $250,000, the HECM product gives the borrower (regardless of age) a much larger line of credit than the proprietary product offered. For a home valued at $1 million, a 65-year-old borrower can have a marginally larger line of credit using the proprietary product ($178,134 versus $172,286). An 85-year-old borrower would have a huge advantage using a proprietary product versus an HECM ($470,234 versus $256,216).