If you’re thinking about taking out a reverse mortgage, it’s important to understand all of its unique features. Did you know that the federally-insured home equity conversion mortgage (HECM) program has a loan payment option that actually grows over time, thereby increasing your borrowing capacity?
The HECM program allows homeowners aged 62 and older to access the home equity they’ve built up in the form of a non-recourse loan. As a borrower, you can spend your loan proceeds however you see fit, but you are required to stay current on your homeowners insurance and property taxes and maintain your home.
Reverse Mortgage Payment Options
Borrowers can choose to receive their reverse mortgage funds in a few different ways, including monthly term or tenure payments, as a line of credit, or some combination of these options. Term payments mean your funds would be split evenly across a predetermined amount of time.
With a term payment, you choose the amount you receive but you must realize that you can exhaust your funds. The loan does not become due at that time and you can remain in the property, but when there are no funds remaining in your line of credit you would no longer receive payments from the reverse mortgage.
If you go the tenure route, you would receive a pre-set monthly amount that depends on factors including your age, life expectancy, and loan amount, for as long as you remain in your home. While payments for the rest of your life sound great, the line of credit option has a feature the others don’t: ongoing growth.
The unused portion of a HECM line of credit actually grows over time, at the current interest rates plus 0.50% monthly (which is the amount of the MIP accrual). So if the interest rate is 4.2% in a given month, your unused line of credit would grow by 4.70%.
Assuming the interest rate remained the same for a year, and your unused reverse mortgage proceeds totaled $100,000, your credit line would grow by approximately $4,700 a year (this number is different with compounding but this is close enough for comparison). The next year your growth would be determined by the new balance and the rate in effect so the growth would be determined on the higher balance that would be close to $105,000 in this example.
That means if you take out a reverse mortgage but don’t access your loan for a certain period of time, your proceeds will grow substantially compared to if you immediately access and draw down the loan.
Tenure Payment Example
For purposes of illustration, let’s use a 73-year-old borrower with a home worth $400,000 who closes a reverse mortgage at todays rates. If he chooses the tenure payment option, he would receive $1,030.92 each month for the rest of his life (this is subject to change with rates and HUD program changes so this is only for illustration purposes – check the most recent reverse mortgage calculator and amortization schedules to see what the results are for your circumstances).
If the borrower lived to be older than 96 years of age, he might ultimately receive more money than if he accessed the same funds every month on a line of credit. Why is that? Simply put, the tenure option keeps paying for life and with the line of credit the borrower can exhaust the funds available if he were to draw at the same rate as is available under the tenure option after age 96.
However, if you don’t need the funds every month (especially in the early term of the loan), he’ll benefit from the growth that’s occurring on the remainder of his line of credit. This could be an important distinction, because it’s possible and actually quite probable that this borrower’s cost of living will increase over time. In this case, borrowers often benefit from a delayed draw or a smaller draw in the early term allowing the Principal Limit to grow.
Remember, the growth is not interest you earn.
This is a greater borrowing power made available to you and you do not accrue interest on these funds unless and until you actually do use them. With the tenure option, that monthly sum you receive as payment from the loan proceeds will stay the same as long as you live in the home and abide by the program requirements (pay all property charges in a timely manner).
With a line of credit, the borrower will have more flexibility to withdraw any amount as needed but if the funds are not needed in the earlier years, the borrower can experience greater credit line growth which gives increased borrowing ability down the road. Another way to utilize the line of credit growth option is to take out a reverse mortgage as soon as you’re eligible, at age 62, and then let it sit—and grow—for 10 years.
Growth Rate Example
In a different scenario, a 62-year-old borrower who qualifies for a $225,807 line of credit reverse mortgage loan (that would be the line of credit remaining after all fees at current rates for a $600,000 home on June 13, 2022), those proceeds will grow almost 75% to $392,643 if left untouched in ten years in a line of credit. Then, at age 72, the borrower could start drawing down that line of credit for retirement, or even convert this to larger tenure payment.
Remember, for a small charge ($50 or less), the servicer can always change your reverse mortgage from a line of credit to a Tenure or vice versa at any time. Most borrowers with line of credit programs choose to remain on the line of credit option but if you find later that you want the payments to be automatic and you do not want to continue to need to request the draw, the option to convert to a term or tenure at a later date is always available.
Now let’s remember a few things here. Firstly, these numbers are based on the HUD calculator and HUD uses the expected rate for calculations – not the start rate. Also, nobody knows what future interest rates will be so the rates used in this calculation, as shown in the HUD calculator, are constant but it is almost a sure bet that the rates will not remain the same over the next 10 years.
As of today, the conventional wisdom is that rates will be rising in the near term but no one can predict the future or how long rates will remain higher but we do know that they will not remain constant for the next 10 years. But since no one can accurately forecast the rates in the future, please use this as a guide and not a guarantee of future performance.
If rates continue to rise, growth rates will be higher. If the rates drop, the growth rates would be lower but then you may benefit from a refinance at that time. It pays to watch the market.
Ultimately, the way you choose to access your reverse mortgage loan depends on your particular situation and financial needs.
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