Reverse mortgages are sometimes advertised as a source of income for the rest of your life. And they can be, under the right conditions.
However, running out of reverse mortgage proceeds sooner than expected is a major risk for consumers who don’t understand this loan product well.
Here’s a look at how you could run out of reverse mortgage proceeds too early under each choice—and how to avoid that scenario.
- There are six different ways to receive reverse mortgage proceeds.
- All reverse mortgage payment plans pose varying levels of risk to borrowers.
- The payment option you choose will affect how quickly and easily you can use up your ability to borrow against your home.
Can You Run Out of Money with a Reverse Mortgage?
All loans and lines of credit come with the risk that the borrower will use the money in a way that might be beneficial in the short term but harmful in the long term. Reverse mortgages are no different.
Ideally, you’ll have a plan for how you will use the money before you even get a reverse mortgage. But if you or a loved one has already borrowed, it’s not necessarily too late to protect your equity so that it’s still available when you need it.
1. Single Lump Sum Reverse Mortgage Option
The single lump sum payment option is the only one with a fixed interest rate. Borrowing a lump sum with a fixed interest rate is normally a lower-risk way to borrow because you always know exactly how much you will have to repay. However, with a reverse mortgage, this loan structure has unique risks.
Back in 2012, a report to Congress by the Consumer Financial Protection Bureau (CFPB) identified the lump sum option as potentially risky, especially for younger borrowers with longer life spans who don’t have other retirement resources. The loan structure puts early-age retirees at risk of using up their equity early in retirement. And at the time, seven in 10 borrowers were choosing the lump sum option.
Why choose a lump sum? Many borrowers have used it to pay off their forward mortgage or other debts so that they no longer have monthly payments, according to the CFPB.
But the bureau also found that lump sum reverse mortgage borrowers were more likely to default and possibly end up in foreclosure because, at some point, they couldn’t afford homeowners insurance, property taxes, or home repairs—all conditions of a reverse mortgage contract.
Taking out a lump sum also puts reverse mortgage borrowers at greater risk of being scammed out of their proceeds. The large sum that they’ve borrowed is an attractive target for thieves—and greedy relatives.
2. Reverse Mortgage Line of Credit Payment Plan
Unlike a home equity line of credit (HELOC), a reverse mortgage line of credit is irrevocable. This means that the lender can’t cancel or reduce it because of changes in the economy, your finances, or your home’s value. You aren’t in danger of losing access to a reverse mortgage line of credit like you are with a HELOC.
A reverse mortgage line of credit has additional features that lower your risk of running out of money. The unused portion of your line of credit grows each year—whether your home’s value increases or not—at the same adjustable interest rate you’re charged on any money you borrow.
Plus, you only pay interest and mortgage insurance premiums on the money you borrow, not on the entire available line of credit. As a result, the balance you owe on your reverse mortgage may grow more slowly compared with other payment plans.
You can generally access up to 60% of your available principal limit in the first year when you have your reverse mortgage line of credit. In the second year and thereafter, you can draw on the remaining 40%—plus whatever you didn’t use in the first year.
Of course, if you use up your entire available credit line early on, you’ll have little to nothing left to use in future years unless you repay some or all of what you borrowed, which will increase your principal limit.
3. Term Reverse Mortgage Payment Plan
Term payment plans provide equal monthly payments with a predetermined stop date. If the end of your term is up before you pass away, then you have outlived your reverse mortgage proceeds.
With a term payment plan, you reach your loan’s principal limit—the maximum that you can borrow—at the end of the term. After that, you won’t be able to receive additional proceeds from your reverse mortgage.
If your home’s value has increased significantly since you took out your loan, refinancing your reverse mortgage to get additional proceeds may be an option. What’s more, it may be an especially helpful option if you have an older reverse mortgage, because maximum principal limits are much higher in 2022 than they were in the past.
4. Modified Term Reverse Mortgage Payment Plan
Modified term plans give you a fixed monthly payment for a predetermined number of months, plus access to a line of credit. The monthly payment will be smaller than if you choose a straight term plan, and the line of credit will be smaller than if you choose a straight line of credit plan.
With a modified term plan, you will only receive monthly payments for a predetermined period, but the line of credit will remain available until you’ve exhausted it. You can avoid running out of money with this plan if you use your line of credit carefully. If you exhaust the line of credit early on, then you may have no equity left to draw on at the end of the term.
5. Tenure Reverse Mortgage Payment Plan
Tenure payment plans have an adjustable interest rate and provide equal monthly payments for life, as long as at least one borrower still lives in the home as their primary residence. If you’re concerned about outliving your reverse mortgage proceeds, consider the tenure plan, which works like an annuity.
The lifetime income guarantee means that the younger you are when you get your reverse mortgage, the smaller your monthly payments will be. Those payments may be too small to provide the financial boost you need.
6. Modified Tenure Reverse Mortgage Payment Plan
Modified tenure provides both fixed monthly payments for life and a line of credit. It gives you a smaller monthly payment than if you chose a straight tenure plan, and your line of credit will be smaller than if you chose a straight line of credit plan.
You could exhaust your line of credit early in your loan term, but you would still receive monthly payments for life. However, the payments will be smaller than they would under a regular (not modified) tenure plan, because some of your home equity goes toward your line of credit.
How to Avoid Running Out of Reverse Mortgage Proceeds
The CFPB warns that younger retirees with longer life expectancies have a greater chance of using up all of their home equity with a reverse mortgage. This isn’t a problem if they are able to age in place—stay in their homes for life—but is if they want or need to move later on.
Thus, waiting as long as you can to take out a reverse mortgage might seem to be one way to limit your chances of outliving the proceeds. Older borrowers receive a larger principal limit than younger borrowers, and you can’t spend reverse mortgage proceeds that you don’t have.
Of course, you could still borrow against your home in other ways, overspend on credit cards, or do any number of things that would hurt your future financial stability. Not having a reverse mortgage isn’t a bulwark against reckless spending.
Getting a reverse mortgage line of credit as soon as you’re eligible—and then leaving it alone and letting it grow until you truly need the money—may actually be the best use of a reverse mortgage, according to current thinking by retirement and reverse mortgage experts such as Wade Pfau and Jack M. Guttentag.
Why not wait? Because of interest rate uncertainty. The lower that interest rates are when you take out a reverse mortgage, the larger your starting line of credit will be. If rates increase, your credit line will increase at the same rate.
If you wait to take out a reverse mortgage line of credit, rising interest rates can wipe out the effect of being able to borrow more because you are older (and, potentially, because your home is worth more).
Changing Your Current Plan
If you’ve already taken out a reverse mortgage and think you may be at risk of running out of proceeds, talk to your lender about changing your payment plan. As long as you didn’t go the fixed-rate, lump-sum route, you can change your payment plan—provided that you can stay within your loan’s principal limit. Changing your payment plan is much simpler than refinancing and requires only a small administrative fee.
The Non-Borrowing Spouse’s Dilemma
Regardless of which payment plan you choose, if you have a younger, non-borrowing spouse, they are at risk of outliving the reverse mortgage proceeds if you die first. Laws that became effective in 2015 protect qualified non-borrowing spouses from having to move out of the house if their borrowing spouse predeceases them.
However, non-borrowing spouses aren’t allowed to receive any additional payments after the borrower dies. This rule makes it easy for surviving, non-borrowing spouses to effectively outlive the reverse mortgage proceeds.
The surviving spouse may be able to sell the house and pay off the reverse mortgage. However, depending on how much the house is worth and how high the loan balance is, selling may not leave the surviving spouse with enough of a nest egg to live on. If the surviving spouse has enough income to qualify for a traditional mortgage, it might be possible for them to refinance out of the reverse mortgage.
If the reverse mortgage balance is higher than what the home is worth, the best option is for the surviving spouse to keep living in the house—selling or letting the lender foreclose will leave the survivor with no place to live and no cash from the home.
A borrowing spouse should make sure that their non-borrowing spouse will not be financially devastated by the loss of reverse mortgage proceeds if the borrowing spouse dies first.
What happens if I outlive the proceeds from my reverse mortgage?
Unfortunately, if you outlive the proceeds from your reverse mortgage, you will have to figure out ways to increase your income—which is unlikely in retirement—or reduce your expenses. If you have enough equity in your home, you may be able to sell your home to pay off your reverse mortgage and use the proceeds to downsize into another place with lower expenses.
How do I know which payment option is right for me?
Choosing the best payment option is tricky and will depend on your personal circumstances and situation. If you are prone to overspending and are concerned about having enough money later on in life, when you may not be able to supplement your income, then taking out a fixed-rate lump sum may be a poor choice for you.
What are some reverse mortgage alternatives?
There are several alternatives to a reverse mortgage. If you can qualify for a refinance, cash-out refinance, home equity line of credit (HELOC), or home equity loan, those all may be better choices. Adjusting your spending habits or downsizing your home can also ensure long-term financial stability into your golden years.
Can I make payments on my reverse mortgage?
Yes, you can make payments on a reverse mortgage to reduce your loan balance during your lifetime, and there’s no prepayment penalty for doing so. Your lender is required to apply any partial repayment first to the interest you owe, then to any loan fees, and last to your principal. However, unlike a forward mortgage, at no time are you required to repay any reverse mortgage principal as long as you meet the contract requirements.
The Bottom Line
A reverse mortgage makes it possible to stay in your home for life even after you have exhausted your home equity. Before you or a loved one takes out this type of loan, it’s important to understand the circumstances under which a reverse mortgage may not provide financial security for life. It’s equally important to understand that with a thorough understanding of how the different payment plans work and how you might prudently use the money, a reverse mortgage can actually help prevent seniors from running out of money in retirement.