Reverse mortgages are practical tools that offer retirees the option to live in their homes and benefit from home equity. People contemplating a reverse mortgage often ask what will happen if they use up all their available equity or they outlive their reverse mortgage.
Outliving vs. Using Proceeds Strategically
Because a reverse mortgage comes due when the last person on the loan dies, it isn’t possible to outlive it. However, it is possible and even likely that a borrower will outlive the availability of loan proceeds.
If borrowers run out of available funds, they can stay in the house, provided they continue to live in and maintain it and stay current on required taxes and insurance. In this sense, they will not have outlived the mortgage, but they will have outlived their ability to borrow more money from it. Whether this presents a problem for the borrower depends on how the reverse mortgage proceeds figure in their financial strategy.
Some borrowers need reverse mortgage proceeds for a specific purpose, such as making home improvements, funding a college education, or traveling. For these borrowers, who likely have alternative sources of income, using up their available equity is part of the plan and, therefore, not an issue.
Other borrowers count on reverse mortgage proceeds to supplement or provide monthly income. Careful planning can ensure that these borrowers have financial plans that account for the possibility of outliving reverse mortgage proceeds.
Reverse Mortgage Payment Options
Reverse mortgages offer multiple payment options, which allow borrowers to structure their mortgage payments to best meet their unique needs.
There are six different ways to receive reverse mortgage proceeds:
Single Lump Sum
Borrowers can receive available proceeds in a single lump sum payment. Because of the 60% utilization rule, with a variable rate, this payment will be made in two installments, the first immediately and the second after 13 months have passed. Fixed-rate reverse mortgage borrowers can only take a single lump sum payment. So, fixed-rate borrowers will only be eligible to take a percentage of the equity that would be available with a variable rate.
Line of Credit
A reverse mortgage line of credit differs from the more common home equity line of credit (HELOC) in that the unused available credit grows over time. Also, unlike the HELOC, the reverse line of credit cannot be rescinded or canceled. Opening a line of credit, but leaving it untouched, allows for more borrowing power in the future that can be used for unforeseen emergencies or to supplement living expenses when current sources of income have been tapped.
Term Reverse Mortgage Payment
Though a reverse mortgage has no specific term, with a term reverse payment, the borrower will receive equal monthly payments ending at a predetermined stop date. If the borrower lives longer than the agreed-upon term, they will outlive their available funds.
Modified Term Reverse Mortgage Payment
This is like the term reverse mortgage payment plan in that a monthly payment is sent to the borrower for a predetermined number of months. Additionally, the borrower also can access a line of credit. Even if the monthly payments end, borrowers can draw funds from any unused portion of their credit line.
Tenure Reverse Mortgage Payment
Borrowers can receive equal monthly payments for life with an adjustable interest rate. Since this is a lifetime income guarantee, there is the risk that monthly payments will be smaller when you’re younger and won’t provide adequate income to meet your financial needs. The upside is that you will likely have some funds for life.
Modified Tenure Reverse Mortgage Payment
Monthly payments will occur during the borrower’s entire life with the option of a line of credit. This plan may have smaller monthly payments, but you can access your line of credit at any time. If you exhaust your line of credit, there is peace of mind knowing the monthly payments will continue.
Strategic Uses for Payment Options
For borrowers to have enough proceeds to last their full lifetimes, choosing the right payment option is important. Keep in mind that no one knows how long they will live, and any strategy requires making an educated guess and including it in their financial planning.
The following questions can help you decide which options will make the most sense for you:
- Will the reverse mortgage proceeds be used as a supplement to other income (i.e., pension, stock dividends, etc.)?
- Do you have adequate cash flow to meet day-to-day expenses?
- What are your outstanding liabilities?
- What other savings and investments do you have to draw from?
There are many strategies for using reverse mortgage proceeds. Whatever reasons a borrower has for taking a reverse mortgage, it’s essential they work with a trusted financial advisor to consider options and plans.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.