How to Choose a Reverse Mortgage Payment Plan
By: Review Counsel Staff
October 21, 2024 • 9 minute read
One of the factors that makes reverse mortgages so appealing is that it gives homeowners several options for how they may receive their funds.
The reverse mortgage payment plan options provide immediate access to equity in the form of a lump sum, monthly payments, a line of credit, or a combination of the three. But how do you decide which one is right for you?
In this article, we break down the differences between the reverse mortgage payment plan options, so you can have the information you need to decide which one, or combination of options, will work best for your situation.
What is a Reverse Mortgage?
There are three types of reverse mortgages, but the most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM). It allows homeowners to access the equity in their home without monthly mortgage payments.
The home still belongs to the homeowners, which means that they are still required to pay the property taxes, homeowners insurance, homeowners association fees (HOA fees), and any maintenance costs.
In order to qualify for a reverse mortgage, you must meet certain requirements, including the following:
- You must be at least 62 years old
- The home must be your primary residence
- You need to have substantial equity in the home
HECM reverse mortgage loans are backed by the Federal Housing Administration (FHA) and U.S. Department of Housing and Urban Development (HUD).
Unlike a traditional mortgage, a HECM is non-recourse, which means that when it comes time to pay back the loan, the homeowners will never owe more than what the home is worth.
With a reverse mortgage loan, older homeowners can remain in their homes while accessing their home equity and receiving tax-free income.
What are the Payment Options on a Reverse Mortgage?
There are three main payment options for receiving the reverse mortgage proceeds: a lump sum, monthly payments, or a line of credit. Borrowers may also opt for a combination of the three.
Here is a breakdown of each option:
- Lump Sum Payment Plans. This option involves receiving a single payment from the lender at the start of the loan.
- Monthly Payment Plans. This option allows you to receive regular payments as long as you live in the home (this is known as a tenure payment plan) or for a set number of years (this is known as term payment plan).
- A Line of Credit. This option gives homeowners access to funds on their own terms until they reach their pre-defined borrowing limit
How Reverse Mortgage Funds May be Used?
Reverse mortgage funds come with total flexibility because there are no rules about how the money can or cannot be used.
Some common uses include:
- Paying off credit card debt
- Making home improvements, such as replacing a roof or remodeling a kitchen
- Purchasing a more reliable vehicle
- Paying for leisure items like boats and vacations
- Providing extra financial security in retirement
- Supplementing Social Security and retirement income
How you decide to receive your reverse mortgage funds will largely depend on how you plan to use the funds.
The Reverse Mortgage Lump Sum Payout
A reverse mortgage lump sum is a single large payout received after closing, similar to a Home Equity Loan or money received from a cash-out refinance. This payment option allows you to receive a large amount of money all at once, which can be used for any purpose.
For the lump sum payment, HUD now limits the maximum amount that borrowers may receive to 60 percent of the loan proceeds after the original mortgage is paid off, if there still is one. After the 60 percent lump sum payment is received, no more money may be disbursed.
Lump Sum Pros
The main advantage of receiving a HECM loan as a lump sum is the immediate availability of the funds. This may be ideal for those who need to:
- Make Major Purchases. This may include major purchases such as buying a more reliable car or another similar expense.
- Make Major Home Renovations. You want to retire in place, but the home where you’ve lived in for years needs upgrades and repairs.
- Pay Off Consumer Debt. A lump sum can help you pay off large amounts of credit card debt or medical bills without having to pay taxes on it, which you would have to do if you had debt forgiven through a deft relief program.
- Emergency Fund. A lump sum can also be used to increase your emergency savings fund.
The other main advantage of a lump sum payout is that it is the only payment option that is received with a fixed interest rate.
If a homeowner plans to use the money toward a large expense, they should only choose this plan if they don’t think they will need additional funds later due to the 60 percent rule.
Lump Sum Cons
While receiving a reverse mortgage as a lump sum may offer some advantages, there are also some drawbacks to consider:
- Principle Limit Rule. You will only receive 60 percent of the total loan amount due to the 60% principal limit rule, also called the 60 percent utilization rule. By comparison, if you receive your money as a line of credit, you will be able to draw from the remaining 40 percent starting in the second year of the loan term.
- Fraud and Abuse Risks. Having a large sum of money sitting in an account may open you up to fraud, abuse, and waste.
- Interest. The entire interest charge will have to be paid at closing. By comparison, if you receive the funds as monthly installments or a line of credit, interest is only charged on the money you receive.
Reverse Mortgage Monthly Payments
There are two main types of reverse mortgage monthly payment plans: tenure and term. This is how the two options work:
- Tenure Payment Plans. Tenure payments provide a steady stream of income in the form of equal monthly payments for as long as you live in the home. The payments are calculated based on borrowers living to 100 years of age. This may be a good option if you don’t know how long you plan to live in the home.
- Term Payments Plans. Term payment plans allow you to receive reverse mortgage funds as equal monthly payments over a fixed number of months. For this option, you will choose how many years you want to receive your funds. This may be a good option if you have a good idea of how long you expect to stay in the home.
Note that if you opt for term payments, the monthly disbursement amount will be more than if you choose the tenure option.
Monthly payment plans come with a variable interest rate.
Reverse Mortgage Monthly Payments Pros
There are several advantages to a reverse mortgage monthly payment plan, including:
- Two Options. As explained above, you have two options for how you are able to receive the funds — term and tenure.
- Supplement income. One of the most common reasons for choosing the monthly payment plan option is that it helps with supplementing your monthly income, making it easier to cover monthly bills and expenses.
- Delay Social Security Benefits. The longer that retirees are able to delay claiming Social Security benefits, the more they will be able to receive. Retirees can use the funds from a reverse mortgage to supplement their income in the meantime.
- Lower Interest and Fees. One of the upsides to receiving the reverse mortgage funds as monthly payments is that you are only charged interest on the money you receive. When you receive the money as a lump sum, you are charged interest on the entire amount at closing.
- Combine with line of credit. Monthly payments may be combined with a line of credit.
Reverse Mortgage Monthly Payments Cons
There are also downsides to going with the monthly payment option for your reverse mortgage:
- Not Enough for Large Expenses. The way the money is received isn’t ideal if you want to pay for large expenses.
- Payments May End. If you choose the term payment plan option, and you stay in the home longer than the term, you will no longer receive payments.
- Payments May Not Be Sufficient. If you choose the tenure payment plan option, the payments may not be enough.
To avoid some of these problems, you will want to have your lender run the numbers to determine what makes the most sense for your situation.
Reverse Mortgage Line of Credit
A reverse mortgage line of credit works in a similar way to a traditional home equity line of credit (HELOC), except that you aren’t required to pay it back in the form of monthly payments.
With a reverse mortgage credit line, the borrowers pay back the loan balance when they no longer occupy their home or sell their property.
According to a study by AARP, the reverse mortgage line of credit is the most popular choice among reverse mortgage borrowers.
Reverse Mortgage credit lines come with an adjustable interest rate.
Reverse Mortgage Line of Credit Pros
There are several advantages to a reverse mortgage line of credit:
- Flexibility and Control. A line of credit gives you a lot of flexibility because you are able to use the money at will or just leave it in the account until you need it. This also gives you a lot of control. You can choose to take a lump sum, pay yourself monthly from it, or just draw from it as you need it.
- Interest Costs. The other upside to a reverse mortgage line of credit is that you only pay interest on the money you use.
- Emergency Fund. If you don’t think you have enough money in your retirement savings, a reverse mortgage line of credit can act as an emergency fund.
- It Can Grow. One of the reasons why the line of credit option is so popular is because money that is left untouched can increase as it accumulates interest.
- Repay Without Penalty. Reverse mortgage borrowers who receive their money as a line of credit may repay the money at any time without penalty.
Reverse Mortgage Line of Credit Cons
While there are a lot of upsides to a reverse mortgage credit line, there are also some downsides including the following:
- Principal Limit Rule. The first year, you can only borrow 60% of your total loan amount.
- Processing period. When you request funds from your reverse mortgage line of credit, it can take up to a few weeks to receive the money. This may make it difficult to pay for immediate expenses.
Bottom Line: Which Reverse Mortgage Payment Plan Should You Choose?
The reverse mortgage payment plan that you choose will largely depend on your needs. If your primary need is to supplement your monthly income, then you may want to choose monthly payments. If your primary need is to fund a large expense such as home repairs or pay off a large amount of credit card debt, you may opt for a lump sum payment. If what you need is flexibility for unplanned expenses, then a line of credit may be the way to go.
You don’t have to choose just one. You may also choose a combination of payment plans. A reverse mortgage specialist can help you understand the best way to go about combining payment plans.
If you are not already working with a reverse mortgage lender, check out our list of recommended reverse mortgage lenders here.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.
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