There are six different ways you can receive the proceeds from the most popular type of reverse mortgage, the home equity conversion mortgage (HECM). The U.S. Department of Housing and Urban Development (HUD), which regulates HECMs, calls these choices “payment plans.”
You can opt to get a large lump sum up front, establish a line of credit that you can draw upon as needed, receive equal monthly payments or pick some combination of these options.
- The Fixed-Rate Payment Plan
- Adjustable-Rate Payment Plans
- Option 1: Tenure Payment Plan
- Option 2: Term Payment Plan
- Option 3: Line of Credit
- Option 4: Modified Tenure Plan
- Option 5: Modified Term Plan
The plan you choose will affect how much money you receive in the short and long run, how quickly you use up your home equity and how effectively a reverse mortgage assists your financial goals. Here’s a look at how each payment plan works and their pros and cons.
- A home equity conversion mortgage (HECM) is a type of reverse mortgage that is available to older homeowners, aged 62 or older.
- HECMs make up the majority of the reverse mortgage market, but there are several ways to receive and repay your loan proceeds.
- Here we look at the mechanics as well as the pros and cons of each option.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau and/or with the U.S. Department of Housing and Urban Development (HUD).
The Fixed-Rate Payment Plan
How It Works
You receive a large amount all at once as soon as your reverse mortgage closes. Interest accrues on that amount, the ongoing monthly mortgage insurance premiums as well as any financed closing costs until the reverse mortgage becomes due and payable. The initial interest rate is higher than it is with the adjustable-rate plans, but the expected interest rate over time is lower.
You should use this type of loan to pay off a high mortgage balance or cover another large expense. “Lump-sum distribution works best for folks who have a large existing mortgage that they need to pay off,” says Casey Fleming, a mortgage adviser in San Jose, Calif., who currently works for C2 Financial Corp. and has more than 30 years of experience in the mortgage industry. He says this is the best option if you need to take all or most of your available proceeds at once.
You cannot receive any additional proceeds from this loan in the future. Borrowers who aren’t good at managing money or who have lost their ability to do so are at risk of squandering the proceeds or spending them too quickly. Scammers sometimes convince seniors to take out this type of loan or target homeowners who recently took one out.
Fleming says the biggest drawback is that “for almost all cases, the maximum draw in year one is 60% of the initial principal limit. Since this option has only one draw, the maximum amount of the loan is quite low.” You retain the other 40% as home equity. You can’t ever borrow against that 40%, but having it can come in handy if you want to sell your home and pay off your reverse mortgage.
To access all of your equity over time, you need to choose an adjustable-rate payment plan.
Adjustable-Rate Payment Plans
The other five reverse mortgage payment plans all have adjustable rates. If you choose one of these, there are three possibilities for how your interest rate can change. Only one will apply to your mortgage, and it will be disclosed in your loan paperwork.
- Your interest rate will adjust once a year based on the Constant Maturity Treasury (CMT) index plus a margin established by the lender. The rate can’t increase by more than 2% per year, and it can’t increase or decrease by more than 5% from the initial rate over the loan term.
- Your interest rate will adjust monthly based on the CMT index plus a margin established by the lender. The rate can’t increase by more than 10% over the loan term, and there is no limit to how low the interest rate can go.
- Your interest rate will adjust monthly based on the London Interbank Offered Rate (LIBOR) plus a margin established by the lender. The rate can’t increase by more than 10% over the loan term, and there is no limit to how low the interest rate can go.
While it does matter which of these scenarios applies to your loan because it affects how much interest your loan accrues over time, it doesn’t matter in terms of affecting your scheduled monthly payments or your available line of credit. A significant change in interest rate with a reverse mortgage doesn’t put you at risk of foreclosure the way it can with a forward mortgage. A higher interest rate does affect your home equity, however, and means that you stand to receive less if you sell the home.
If you plan to stay in your home for the rest of your life, interest rate increases may not be a major concern. If you don’t, you may want to make sure your loan’s interest rate matches the first scenario, as the maximum interest rate increase is 5% instead of 10%. Your loan officer and reverse mortgage counselor can help you understand your choices and how adjustable interest rates affect your situation.
When you are applying for a reverse mortgage with an adjustable interest rate, the illustrations of your payment plan options will use an expected interest rate. This is the lender’s best guess at what the adjustable interest rate will average out to over the life of your loan. It’s one of the three key factors in determining how much you can borrow, along with the youngest borrower’s age and the property’s value.
Now that you have a general understanding of how adjustable-rate plans work, let’s review your five payment options. Remember that “payment” in this context refers to how you’ll receive the loan proceeds.
Option 1: Tenure Payment Plan
How It Works
In a tenure payment plan you get equal monthly payments as long as at least one borrower lives in the home as a principal residence. Monthly payments are calculated under the assumption that you’ll live to be age 100. If you don’t expect to live that long, a term payment plan, discussed next, might be a better option. If you live longer, you’ll continue receiving payments. If you want to receive a steady monthly payment for the rest of your life in your home, the tenure payment plan is a good choice.
“Tenure payments are great for those who think they will live in the home a long time, and who need stable monthly income,” Fleming says. You don’t have to worry about running out of reverse mortgage proceeds with a tenure payment plan as long as you continue to meet the loan’s other terms.
If you have any large bills to pay off, this plan won’t help you pay them. Also, while this payment plan seemingly provides guaranteed income for life, if you have to move out of your home for health reasons – or if you fail to keep up with required property charges, such as homeowner’s insurance, property taxes and basic maintenance – the reverse mortgage will be due and payable (this is true under any payment plan), and you won’t receive any further payments unless you cure the default
You or your heirs will receive whatever money is left from the sale of your home after the reverse mortgage is paid off. However, in a worst-case scenario of a depressed real estate market combined with high interest rates, you might not come out with much cash.
Option 2: Term Payment Plan
How It Works
You get equal monthly payments for a set period of time, or term payment plan, that you choose – 10 years, for example. “Term payments are best if you have a clear idea of how long you will live in the home,” Fleming says. “Older folks – 80 and up – or those who want to move away in a few years may select this type.”
The monthly payout is higher compared with a tenure payment plan. Although you will not receive additional monthly payments after you reach the end of the loan term, you will be able to keep living in the home as your principal residence until you die or move out (as long as you continue to meet the other loan conditions, such as paying your property taxes).
You won’t get a steady income for life unless you happen to die during the loan term. You might use up your home equity too early in your life and not have another source of funds to rely on.
Option 3: Line of Credit (LOC)
How It Works
With a line of credit you get access to money as you need it without any obligation. You can decide when to draw upon your credit line and how much to take, as long as your balance is below the principal limit. Your lender can’t require you to withdraw a minimum amount or to withdraw a minimum sum on a set schedule.
A line of credit provides a lot of flexibility. You can withdraw a large lump sum up front, then borrow additional funds over time, and you get access to that additional equity that remains locked up with the fixed-rate payment plan. You can also leave the line untouched for years in anticipation of a day when you might need it. You can withdraw equal or similar amounts each month, too. Basically, you can customize your withdrawals to your needs and adjust them as your needs change.
A line of credit can work like a lump-sum, tenure or term plan, but you have more control. Also, the unused portion of your line of credit grows over time at the same interest rate that you’re paying on the amount you’ve borrowed. In addition, you only pay interest on the money you actually borrow, which can make it easier to sell and move later or potentially leave money to your heirs. Unlike a home-equity line of credit, a reverse-mortgage line of credit cannot be revoked, even if your home’s value decreases or your financial situation worsens.
You can burn through a line of credit by borrowing the 60% maximum of your principal limit in year one and the remaining 40% on day one of year two. If you do that, you’ll be out of access to funds. Also, it can take up to five business days to receive funds you request from your line of credit, so you must make sure you keep enough cash in your checking account for urgent needs.
Option 4: Modified Tenure Plan
How It Works
You get fixed monthly payments combined with access to a line of credit for as long as one borrower occupies the home as a principal residence. The fixed monthly payments will be smaller than if you get a straight tenure plan, and the line of credit will be smaller than if you get a straight line of credit plan, but you’ll have access to the same total amount of funds.
You have flexibility both in establishing your monthly payments and choosing the size of your credit line. If you want larger monthly payments, you can choose a smaller credit line. If you want a larger credit line, you can opt for smaller monthly payments.
It lets you meet your regular monthly cash-flow needs without borrowing more than you have to. This option keeps your interest expense down and puts you at less risk of using up all your equity and not being able to afford to move should you want or need to later.
If you need a large sum right away, this payment plan probably isn’t your best option.
Option 5: Modified Term Plan
How It Works
You get a fixed monthly payment for a predetermined number of months, plus access to a line of credit for as long as one borrower maintains the home as his or her principal residence. The fixed monthly payments will be smaller than if you get a straight term plan, and the line of credit will be smaller than if you get a straight line of credit plan, but you’ll have access to the same total amount of funds.
You have flexibility in establishing the size of your monthly payments and for how long you’ll receive them, and they will be higher than they would be under a modified tenure plan, assuming the same size credit line. You also get flexibility in choosing the size of your credit line.
At the end of the term you’ll still have access to loan proceeds if you haven’t used up your line of credit. As with the modified tenure plan, you can keep your interest charges down and possibly have enough equity left to move later on.
You could run out of reverse mortgage proceeds. You only receive monthly payments for a set number of months or years, so you must use your line of credit carefully if you expect to need income beyond the end of the term. This plan also isn’t the best choice for large, up-front cash needs.
The Bottom Line
HECMs offer so many payment plans because senior homeowners have many different financial needs. No particular option is universally good or bad. “Which option is best depends entirely on the client’s situation and needs,” Fleming says. However, he continues, “as a general rule, I favor the line of credit over tenure or term payments,” explaining it’s because the line of credit lets you take monthly withdrawals, just as you could with a tenure or term plan, but gives you the flexibility of taking out more in an emergency and accrues interest savings if you don’t need to use it.
Do your research and ask lots of questions of your lender and reverse mortgage counselor to figure out which payment plan is best for you.