Proprietary Mortgages vs. Home Equity Conversion Mortgages

If you’re age 62 or older and own a home, you may have heard of reverse mortgages. This financial tool offers a way to turn your home equity into liquid cash in a lump sum, on a monthly basis, or in a line of credit. For many who struggle on a fixed income, reverse mortgages can provide breathing room financially while still allowing you to stay in your beloved home.

The concept of a reverse mortgage is relatively simple, but three different types are available, depending on your income level. We’ll discuss the differences between a home equity conversion mortgage (HECM) and a proprietary or jumbo reverse mortgage.

How a Reverse Mortgage Works

A reverse mortgage is a loan that borrows against the equity in a home. Reverse mortgages are only available for seniors over age 62 with substantial home equity. After applying, the money borrowed is paid to the homeowner through a lump sum, a monthly installment, or a line of credit.

The homeowner must be able to stay up to date on all property taxes and keep the house in good repair. The loan is repaid when the homeowner dies, sells the house, or moves out of the house for more than 12 consecutive months. After they’ve vacated the house because of one of these reasons, the house is sold, and the proceeds from the sale pay the lender for the amount borrowed plus interest charges and service fees.

How an HECM Works

Home equity conversion mortgages (HECMs), also known as Federal Housing Administration (FHA) reverse mortgages for seniors, are reverse mortgages that the FHA backs. That link to the government comes with more regulations but also with a measure of safety for you.

Since HECMs are insured by the FHA, they can be offered only by an FHA-approved lender. They also require every borrower to attend a U.S. Department of Housing and Urban Development (HUD) mortgage counseling session, where an advisor can help show how the HECM will impact the borrower’s financial life. This helps cut down on mortgage scams, which can be a big problem.

The standards for an HECM are simple:

• You must be age 62 or older.
• You must occupy the house, condo, or multifamily unit as your primary residence.
• You must have considerable equity—generally interpreted to mean 50% or more.
• You must be able to pay your property taxes and homeowners insurance and to maintain the home.
• You must not be delinquent on any federal debt.

HECM amounts are based on your equity and your age, the current interest rate, and the lesser of the appraised value or the mortgage limit of $970,800. This keeps people from borrowing far too much and ending up underwater on their mortgage.

The one drawback of an HECM is that there are additional fees. HECMs are considered nonrecourse loans, which means that even if you end up borrowing more than your available equity, the lender cannot force you to move. To help protect lenders, each HECM is subject to up-front mortgage insurance premiums of 2% of the total loan at the time of closing, and over the life of the loan, you’ll need to pay an annual mortgage insurance premium of 0.5% of the outstanding mortgage balance.

HECMs also require origination fees, such as title fees, appraisals, and so on, necessary for any loan closing. Any service fees are capped at $35 per month.

How a Proprietary or Jumbo Reverse Mortgage Works

A proprietary or jumbo reverse mortgage may be in order for those with higher-value homes. Since an HECM has a cap on the amount that you can borrow, those who are house rich may want to tap more than the allowed amount. A proprietary reverse mortgage can exceed the FHA limit, although it will seldom come close to borrowing your full equity amount.

Since proprietary reverse mortgages aren’t backed by the FHA, they aren’t subject to FHA regulations, such as the mandatory counseling session or up-front and ongoing mortgage insurance payments. While this may seem like a good thing, it also strips away the layer of protection for seniors. Lenders who might not qualify for FHA backing can offer proprietary reverse mortgages.

Proprietary reverse mortgages also tend to have lower up-front costs than HECMs. Eliminating mortgage insurance is a big part of this. However, HECMs tend to have lower interest rates than proprietary reverse mortgages. You’ll need to do the math to determine which is a more cost-effective option for your specific situation.

The Bottom Line

While HECMs and proprietary reverse mortgages both offer the ability to borrow against your equity, HECMs do so with more protections in place for you. HECMs are also much more common than proprietary reverse mortgages, so finding the right lender for a jumbo reverse mortgage might be more difficult. If you have a high-value home and need a significant amount of money, a jumbo reverse mortgage may be your only option. Just remember, you should still speak with a trusted advisor about the pros and cons of each type of reverse mortgage.