Different Ways of Accessing the Money in a Reverse Mortgage
They can then take tax-free money out of a Reverse Mortgage in three ways.
- They can take a lump sum; meaning all the money up front. We use this choice when the borrower has an existing mortgage or equityline. That has to go away as part of the process. Do you have any mortgages?
- They can choose a line of credit; sort of like a jumbo credit card that they can draw from as needed but only are charged interest on the part they actually use.
- Or they can take monthly payments
- Or they can take a combination of all three.
Taking Money Up Front - Referred to as Lump Sum
Anyone with an existing mortgage will be using this choice, at least in part, since all existing liens must be removed as part of the reverse mortgage.
Many people choose to take some funds up front to pay off car loans, credit cards or other obligations. This is usually a better way to take money to pay off other debts rather than taking monthly payments from the reverse mortgage and applying them to the debt.
Nearly all the fixed rate choices require that all the funds available be taken up front. (Beginning in late 2013, lenders are starting to create new versions of the HECM that allows future draws to be fixed. See Interest Rate Choices for more on this.) This means interest on the full amount begins immediately and monthly payments or a line of credit is not available. This is beneficial for someone with a large mortgage or some other need for most of the funds available. For those without a large need of all the funds initially, it may be better to choose the adjustable rate so the balance doesn't build so fast as well as allowing the line of credit to grow with more flexibility in the future.
There are two ways monthly payments are calculated. One is called tenure. The other is called term.
Tenure means for the life of the borrower(s) or until they choose to make a change. When taking monthly payments, this is usually the best choice if the dollar amount is sufficient for the borrower(s) needs.
Term is for a fixed amount of time. This option is usually chosen when the tenure option doesn't provide enough money to meet the borrower(s) needs. It may also be chosen if there is a known fixed amount of time the money is needed. Perhaps a Jumbo CD is coming due in 12 months at a high interest rate and the borrower doesn't wish to break it. Choosing a term payment for 12 months may be the right way to close the gap.
Line of Credit - also referred to as LOC
Think of a line of credit as a jumbo credit card. You can draw from it as you need money. You are only charged interest on the part you actually use.
The LOC with a reverse mortgage is unusual in that it also grows. The amount available grows at the same interest rate the borrower is being charged. Using my credit card example, imagine you have a card with a $10,000 limit. After you have had it a year, you call their 800 number and ask if they can increase your limit. Without you having to reapply, they agree to increase the limit to $10,500. That is a 5% increase in how much you can use. This is similar to the growth of the LOC except it happens automatically.
Sometimes I heard people think the LOC money is put into a lender bank account and then think of the growth as interest. Again, like a credit card, the amount available to the borrower is a paper entry and no physical cash has moved until the borrower decides to draw some amount from the LOC. In the same way, while the amount of growth is based on an interest rate (again, the same amount the borrower is being charge - not 5% in my example) it is not interest. The borrower will not be sent a 1099 (like a bank sends for interest paid) that might require tax to be paid.
You may also combine the three choices. This happens a large percentage of the time. You may have
1. Lump Sum and Payments,
2. Lump Sum and LOC,
3. Lump Sum, Payments and LOC,
4. Payments and LOC
The Flexibility of Making Changes to Your Plan
You may make changes to how you take your money at any time. This is called a recalculation. Most lenders charge a nominal amount - think $20. It takes approximately 30 days and a small amount of paperwork that you need to sign and return before the plan can take affect.
Having this option means the decision you make at the time of application is not your final decision. Things change in our life and it is a great relief to know the way you use your money in a reverse mortgage can be changed.
One example may be that initially all the money was put in the LOC for casual uses such as trips or occasional big purchases. Then a change occurs where some income stops coming in. This may be because one of the borrowers dies and one or more of the income checks is gone from the household income. It may also be from most any other financial change in one's life that just seems to happen.