Most traditional loans do not offer borrowers choices for the way they receive their proceeds. In contrast, Reverse mortgages offer different payout options and allow borrowers the unique option of combining them. This feature allows borrowers to tailor how they receive proceeds to their financial plans and situation. The following are different ways borrowers can elect to receive their reverse mortgage proceeds.
Option 1: Lump Sum Payout
A lump sum payout means the borrower will take all their available equity as a single payment. This is similar to the way funds are distributed with a conventional loan. Though reverse mortgage proceeds are referred to as a single payout, that’s not entirely accurate. Due to an FHA rule commonly known as the 60% utilization rule, only a percentage of the available proceeds will be available as a lump sum at mortgage closing. The structure of their loan will further determine how much cash borrowers can ultimately take out of their loan.
- Adjustable rate HECM. Borrowers can take the remaining 40% of their balance after one year.
- Fixed-rate HECM. Borrowers can only take the initial 60%, meaning that equity available with a fixed rate HECM will always be less than equity available with an adjustable rate. The lump sum option is the only payout option available to fixed-rate HECM borrowers.
The 60% Utilization Rule
Home equity conversion mortgage HECM borrowers may only take the greater of 60% of their total available equity or the total amount of their mandatory obligations plus 10% in the first payout.
The total amount of available proceeds is determined by several factors including the value of the home, how much equity is in the home, and the FHA lending limit. The 2023 FHA HECM lending limit is $1,089,300. No matter how much the value of the home or the borrower’s equity, they cannot take out more than that amount with a HECM.
Borrowers also have mandatory obligations to pay before they can access the equity. Mandatory obligations may be the balance of their previous mortgage or other liens on the home. When calculating how much cash a borrower can take in their lump sum, the lender adds up the borrower’s mandatory obligations and adds 10%. They compare that number with 60% of the total available equity to determine how much a borrower can take in their first payment.
Option 2: Monthly Payments
Monthly payments allow the borrower to receive a set amount from their available equity. The loan balance grows as they receive their payments. Interest is charged on payments received. There are two possible structures for reverse mortgage proceeds to be received as monthly payments.
- Term Payments. Monthly payments can stretch over five, 10, or 20 years or another timeframe that works for the borrower. Since the lender sets the exact term over which the borrower will receive payments, the borrower’s monthly payment tends to be higher than the second monthly payment option.
- Tenure Payments. These payments are designed to last the borrower for life. They will likely be lower than term payments because they need to cover a longer, less definite period. This option is available as long as the borrower lives in the home as a principal residence, pays property taxes and insurance, maintains the home, and complies with all loan terms.
Deciding between a term versus a tenure payment plan depends on the borrower’s financial strategy and other factors, including the amount of available equity and their plans for the future.
Option 3: Line of Credit
A line of credit allows reverse mortgage borrowers to keep their available equity in reserve for a later date. A unique feature of a line of credit with a Home Equity Conversion Mortgage is that the amount of credit available grows over time in relation to the amount of interest charged on the principal.
To keep a reverse mortgage open, borrowers must maintain at least a $100 loan balance. But any equity above that can be put into a line of credit. The key feature of a line of credit is that it can remain untouched for years for borrowers to tap as needs arise.
Option 4: Payout Combinations
Options for payout combinations include taking a lump sum and receiving the remainder of the funds through monthly payments or a line of credit. Borrowers can also combine the modified term or tenure payments with a line of credit.
- Modified Term Payments Combined with a Line of Credit. Borrowers can combine monthly payments for a fixed period and access a credit line later. Monthly payments could address current needs, and the line of credit could be used for emergencies later.
- Modified Tenure Payments Combined with a Line of Credit. As long as borrowers live in the home, they can receive modified tenure payments. Under this plan, a borrower will receive smaller amounts but can access a line of credit anytime. Even if a borrower exhausts their line of credit, the monthly payments will continue.
In tenure-based or modified tenure plans, payments continue so long as the borrower lives in the home as their principal residence, pays all property taxes and insurance, maintains the home, and complies with all other loan terms. With modified tenure plans, the lender will set aside a specific amount of money for a line of credit.
Can You Change the Way You Receive Your Loan Proceeds?
It is possible to change the way you want to receive your proceeds.
- Before Closing. If borrowers decide before closing to receive monthly payments instead of a lump sum, they can change their minds about receiving proceeds.
- After Closing. After closing, a borrower can change how they want to receive proceeds if they pick a payout option other than a lump sum at a fixed rate. The servicer can assist in making the change to the borrower’s payout method. Changing proceeds post-closing may require a servicing charge.
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.