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4 Min. Read

How Does a Reverse Mortgage Line of Credit Work?

A man reviewing information about his reverse mortgage line of credit

A reverse mortgage line of credit has some unique features that distinguish it from the more widely understood home equity line of credit (HELOC). While both financial vehicles offer homeowners the ability to tap their home equity, there is more to understand about how they differ. Using a HELOC as a jumping-off point is a good way to illustrate the unique advantages of a reverse mortgage line of credit.

Reverse Line of Credit Versus a Home Equity Line of Credit

A home equity line of credit is a short-term loan with a fixed draw period, usually 5-10 years. Homeowners approved for a HELOC can tap the funds at any time, similar to how they might use a credit card. The HELOC is fixed at a specific amount, and available funds decrease as credit use increases. Also, like a credit card, a HELOC is not guaranteed and can be canceled or revoked for various reasons. 

A line of credit in a reverse mortgage, also known as a home equity conversion mortgage (HECM), works a bit differently. Like a HELOC, reverse mortgage borrowers are not required to use the line of credit immediately or at all, and only funds withdrawn are charged interest. 

However, unlike a HELOC, which has a fixed amount of available credit, the amount available from a HECM line of credit can grow over time. As the principal limit grows over time, the homeowner’s line of credit borrowing power increases as long as the loan has not matured or the borrower has not defaulted. 

All money borrowed from the line of credit gets added to the loan balance. And, because HECMs are federally insured, a reverse mortgage line of credit can’t be frozen if the home drops in value. 

When the borrower takes the reverse mortgage, they may elect to take equity out as cash and keep it available for the future as a line of credit or a combination of the two. The amount available through the line of credit depends on the amount of available equity and how much the borrower chooses to take as cash payments.  

For instance, a HECM borrower eligible to take $100,000 (after fees) of equity out of their home and who chooses to take a payout of $50,000 cash will have access to an available line of credit of $50,000 on day one of the loan. However, by day two of the loan, that available credit will have started growing. 

A HECM Line of Credit Grows Over Time 

A unique feature of a reverse line of credit is that it grows over time at the same rate as the interest plus the annual mortgage insurance premium (MIP) charged to the loan (0.50% of the principal). Even if the borrower’s home depreciates, the mortgage line of credit will continue to grow at the same rate. 

Using the example of the borrower above, on day one of their loan, that borrower will have $50,000 available in a line of credit. However, that available $50,000 will immediately increase at the interest rate applied to the principal plus the ongoing mortgage insurance premium rate. Because interest begins accruing immediately on the loan principal, the borrower will start the next month with an increased loan balance and a higher line of credit. 

What Is the Mortgage Insurance Premium (MIP)?

Homeowners with federally insured HECM loans pay mortgage insurance premiums or MIPs that allow the Federal Housing Authority to insure these loans. HECM borrowers pay an upfront MIP of 2% of the home value, and an annual MIP which is 0.50% of the loan amount. This fee is added to the balance of the loan.

How Do You Take Out a Reverse Mortgage Line of Credit?  

Getting a reverse mortgage line of credit is not a complicated process. A borrower has four payout options once their reverse mortgage loan is approved: a lump sum, monthly payments, a line of credit, or a combination of all three. The homeowner chooses how they will receive their funds after the loan is approved and before it closes. If the borrower selects a line of credit, the amount is set aside, and the funds are made available to the borrower when needed. 

Are Borrowers Required to Get a Line of Credit?  

There is no requirement that a reverse mortgage has a line of credit attached to it. However, with a unique growth structure and the fact that they cannot be canceled due to a decrease in home value, these lines of credit can offer a safety net that borrowers may or may not ever need to access. They also allow older homeowners to leverage home equity while protecting other investment sources.  

With these and any other financial vehicles, it is always wise to enlist the services of a professional financial advisor to help you weigh the pros and cons and consider all options.