Home Equity Conversion Mortgage (HECM) borrowers can receive payouts — which are called distributions — in different ways. The distribution method that is right for you depends on your objectives and circumstances. The better you understand your goals, the happier you will be with your reverse mortgage.
You can use a reverse mortgage to accomplish a variety of financial goals. For example, you can use payouts to fund investments, start a business, improve your quality of life, create an economic safety net, prevent foreclosure or buy a new home with no mortgage payment. You can take your HECM reverse mortgage proceeds in these ways:
- Lump sum distribution
- Monthly payments for a specified period (term)
- Monthly payments for life (tenure)
- Line of credit
- Combination of the above options (for example, a line of credit plus monthly payments)
There is no best reverse mortgage distribution method that works for everyone. You need to pick the right distribution that fits you. HUD-approved reverse mortgage counselors or trusted financial advisers can help you evaluate your options, but you need to decide which choice will make you happiest.
Lump Sum Payout
The lump sum option delivers 60 percent of your maximum loan amount in a single lump sum when you close on your reverse mortgage. If you choose a variable interest rate, you can take the remaining 40 percent 12 months after closing. The lump sum distribution is the only method that allows you to choose a fixed-rate reverse mortgage. However, if you choose the fixed rate, you forfeit access to the other 40 percent of your maximum loan amount. (Note: Different rules apply if you use your lump sum to pay off an existing mortgage on your home.)
The lump sum distribution is the most popular payout option, perhaps due to the myriad ways borrowers can use it. For instance, you can prevent foreclosure, generate funds for an investment, downsize to a new home or consolidate debt.
Here are four examples of different uses for a lump sum distribution:
If you have a lot of home equity but have trouble paying your mortgage, a reverse mortgage could make that mortgage and payment go away. Depending on your age, the interest rate and your property value, you may also be able to get some extra cash or a line of credit.
Mortgage financing is one of the cheapest ways to fund an investment. If you can earn more on your investment than the interest rate of your reverse mortgage, it might be worth pursuing. Experts recommend you consult an accountant or financial planner when considering this strategy.
Buying a rental or second home
You can do almost anything you like with your reverse mortgage lump sum. Because you don't need great credit or a large income to qualify, it's easier to purchase rental property with a reverse mortgage than it is to try to get an investment property loan. The downside is that your lender won't be appraising the rental or analyzing its income potential, as it would if you were getting a traditional mortgage. So it's important that you do your homework. Make sure the property will generate enough income to offset the loan fees and interest. Reverse mortgage proceeds may also be used to buy a vacation home. Be certain you will be able to keep up with the maintenance, taxes and insurance for both your current home and the new property. Remember, if you switch your primary residence to the new property, the reverse mortgage on your former home becomes due and payable.
Buying a new home
Reverse mortgages can also be used to downsize to a new home. This is called a reverse mortgage for purchase. This allows you to buy a home without paying all cash, and you won't have a mortgage payment.
Monthly Payouts: Term or Tenure
Regular, predictable income from monthly payments can substantially improve your quality of life and solidify your financial security. You can choose to receive monthly payments in one of three ways:
Receive monthly payments of equal amounts for a set period—for five or 10 years, for instance. Term payment amounts are almost always higher than tenure payment amounts because the lender knows the maximum time period you can receive funds. Suppose, at 62 years old, you've recently retired and want to delay receiving Social Security benefits until you turn 67, when you become eligible for higher payments. Monthly reverse mortgage payments for a five-year term can see you through until you qualify for higher Social Security benefits. Term payments are also suitable if you have plans to sell your home in five years. You can receive higher payments during this period than you would by selecting the tenure payment option.
Receive monthly payments of equal amounts for as long as you live in your home. Tenure payment amounts are typically smaller than term payments, because the arrangement is open-ended - lenders don't know how long they'll be paying you. However, you're guaranteed these payments even if your loan balance eventually eclipses your home's value. The tenure monthly payment is the only option that guarantees you won't outlive your loan as long you live in and maintain your home as agreed.
Modified tenure or modified term
Reverse mortgages are often touted for their flexibility. You'll find flexibility in distribution methods, too. You can choose a hybrid distribution method that combines a line of credit with a smaller distribution - for example, you can select smaller monthly payments for basic needs and add a line of credit for emergencies.
A word of caution: Regardless of the distribution method, low-income retirees who receive Medicaid or SSI payments need to pay attention to the way they receive and use reverse mortgage funds. Usually, monthly reverse mortgage payments don't count as income, and they don't count as assets if spent in the same month they're received. If you don't spend your payment within a month, however, it could push your asset totals beyond the allowable limits for Medicaid or SSI eligibility. Straining your asset totals could result in a loss of Medicaid or SSI.
Line of Credit
A reverse mortgage structured as a line of credit is the most versatile and perhaps the cheapest solution for borrowers who don't need immediate access to a large sum of money. You can choose a line of credit or combine a line of credit with other distribution methods. For example, you could take out a lump sum (with a variable interest rate) to cover immediate cash needs and add a line of credit for future needs. Your credit line can act as a backstop for a new business, a fund for medical emergencies or budget source for annual vacations.
Perhaps the greatest advantage of a line of credit is that you only pay for what you use. Lines of credit, unlike other payment options, increase over time. By taking one out while current interest rates are low and principal limit factors are high, you can secure a higher credit line at a lower cost. If you refrain from using the credit line early on, you save on interest and insurance costs and can significantly increase your available credit later.
How does your HECM credit line grow? Any unused portion of the credit line grows at an annual rate equal to the interest rate the lender charges on the amount you withdraw. Suppose, for example, Jeff has a $120,000 HECM line of credit. He withdraws $20,000 at closing at an interest rate of 4 percent and doesn't withdraw any additional funds in the first year.
Growing a HECM Credit Line
Jeff has a $120,000 HECM line of credit. At closing he withdraws $20,000, then leaves the HECM untouched.
After 1 year, Jeff's balances are...
After 5 years, Jeff's balances are...
HECM Balance - $20,815
HECM Balance - $24,420
Available Balance - $135,296
Available Balance - $158,730
The unused portion of a reverse mortgage credit line grows over time. This unique growth characteristic of the line of credit makes it a great distribution method for covering future cash needs. Jack Guttentag, the self-dubbed "Mortgage Professor," says current low reverse mortgage rates present opportunities that have never existed before — including the chance to get a high credit limit while paying very little for the credit you use.
What Happens When a Reverse Mortgage Ends
Eventually, reverse mortgage balances become due and payable. You can repay the loan with savings. You may instead choose, as many borrowers do, to sell the home and use the proceeds to pay off the balance. You keep any funds that remain after payoff.
But what if the opposite happens and the loan balance exceeds the property value? If your reverse mortgage is a HECM, you are never responsible for a shortfall. HECMs are non-recourse loans, which means you can clear the debt entirely through the proceeds from the sale of the home even if the loan balance exceeds the property value. In such a case, the FHA steps in and covers the shortage. Exceptions do occur, however, because not all reverse mortgages work this way. If your reverse mortgage is not a HECM but a proprietary reverse mortgage, you may be held liable for a deficiency.
Non-Borrowing Spouses and Reverse Mortgages
When a reverse mortgage balance becomes due and payable is not always clear. If a married couple resides on the property, and only one spouse is listed as a borrower in the reverse mortgage documents, the eligibility status of the non-borrower spouse (as defined by HUD) determines whether the loan becomes due and payable upon the borrower's death.
Why Exclude Spouses from a HECM?
Until recently, a couple hoping to obtain the highest possible loan amount with a HECM reverse mortgage could effectively do so by excluding the younger spouse from the loan and the home's title. Excluding a younger spouse increased the maximum loan amount because the youngest borrower's age was a main factor in HUD's calculation of the maximum allowable loan amount. The older the borrower, the higher the loan amount. The younger the borrower, the lower the loan amount. Putting only the older spouse on the home's title and making the older spouse the sole reverse mortgage borrower allowed couples to borrow more.
Unfortunately, this strategy could backfire, and often did, if the borrowing spouse died before the non-borrowing spouse. Because the younger non-borrowing spouse was not listed on the home's title or reverse mortgage loan documents, he or she could no longer reap the benefits of the reverse mortgage. The surviving spouse had to quickly find a way to pay off the loan balance or face eviction by the lender.
Eligible Non-Borrowing Spouses and HECM Rules Today
Cognizant of this growing problem, HUD altered HECM guidelines in 2014. For HECM loans closing on or after Aug. 4, 2014, HUD bases the maximum loan amount on the age of the younger spouse, and it doesn't matter if he or she is on the property title or obligated by the HECM loan documents. HUD further requires HECM lenders to identify the non-borrowing spouse in the loan documents if the spouse is living in the home. Once a non-borrowing spouse is identified in the loan documents, the spouse is considered an "eligible" non-borrowing spouse.
If the borrowing spouse dies first, the eligible non-borrowing spouse may continue living in the home as long as the spouse maintains the residence and pays property-related expenses (usually property taxes and homeowners insurance). The surviving spouse must establish within 90 days that he or she has the legal right to inhabit the home.
Eligible non-borrowing spouses won't be able to draw additional funds from the HECM, and interest charges on the balance will continue to add up, but they can continue living in the home for the rest of their lives.
Ineligible Non-Borrowing Spouse and HECM Loans
A non-borrowing spouse is considered ineligible, however, if he or she wasn't married to the borrowing spouse at the time the HECM was taken out, or wasn't living in the home with the borrowing spouse. Ineligible non-borrowing spouses aren't identified on the HECM documents, and their age is not a factor in maximum loan amount calculations. Eligible spouses become ineligible if they divorce or separate from the borrower. An ineligible spouse doesn't have the benefit of a deferral, which means the reverse mortgage balance becomes due and payable when the borrowing spouse dies. Ineligible non-borrowing spouses are required to pay off the loan or vacate the property.
4 Examples of HECM Spousal Classifications
Here are four examples of how a spouse might be categorized under FHA HECM rules: borrower, eligible non-borrower, or ineligible non-borrower.
Both spouses older than age 62
Under FHA HECM rules, when both spouses are older than age 62, both are borrowing spouses regardless of whether one or both spouses' names appear on the property's title. The older or younger spouse can be the property's sole owner. This rule does not vary if the property is situated in a community property or a common law state. For the purposes of the HECM loan, both borrowing spouses have the same rights and responsibilities.
One spouse older and the other younger than age 62
Under FHA HECM rules, the spouse older than 62 is the borrowing spouse. The spouse younger than age 62 is the eligible non-borrowing spouse. This means after the death of the borrowing spouse, eligible non-borrowing spouses can defer vacating the property and repaying the loan. Whenever a reverse mortgage includes an eligible non-borrowing spouse, his or her age must be used to calculate the loan amount because the potential for deferral increases the possibility of the loan balance outstripping the home value. The rules are the same whether the property is in a community property or a common-law state — an eligible spouse doesn't need to be on the property's title.
One spouse older than age 62 and the other resides elsewhere
Under FHA HECM rules set in January 2015, a non-borrowing spouse can fall into the ineligible non-borrowing spouse category several ways. First, by marrying the borrowing spouse after the reverse mortgage closed. Second, by starting out as an eligible non-borrowing spouse, and then moving out to reside elsewhere permanently. Third, by starting out as an eligible non-borrowing spouse and then failing to submit an annual statement indicating he or she still resides in the property. And finally, by the borrower failing to disclose he or she was married at the time the reverse mortgage closed.
Single person has a reverse mortgage and gets married
Under present FHA HECM rules, an undisclosed (or future) spouse is considered an ineligible non-borrowing spouse. Should the borrowing spouse die or move out to reside elsewhere permanently, the ineligible non-borrowing spouse must either vacate the property or pay-off the reverse mortgage.
How Heirs Pay Off a Reverse Mortgage
What happens when the last reverse mortgage borrower dies? How do the borrower's estate or heirs immediately pay off the reverse mortgage balance, and how will they know the amount of the payoff? Here is the four-step payoff process:
Upon the borrower's death, the estate executor notifies the reverse mortgage lender. Reverse mortgage lenders generally track borrower deaths through public records and take action to terminate a loan when the last borrower dies. If the borrower was receiving monthly checks from the reverse loan at the time of death, the lender ceases making payments. If the borrower had a line of credit at the time of death, the lender closes the line of credit.
Within 30 days of notifying the borrower's estate or heirs, the HECM lender dispatches a HUD-approved appraiser to the property. The appraiser evaluates the home and assigns an appraised value, which the lender uses to determine the loan amount that is due and payable. This amount is the lesser of the reverse mortgage balance or 95 percent of the appraised value of the property.
Six months to satisfy the debt
Your estate or heirs have six months to pay off the loan — either by refinancing the reverse mortgage loan, selling the property and using the proceeds from the sale, paying off the balance with other funds or simply turning the home over to the lender. Until the loan is repaid, your lender continues to charge interest on the balance and monthly insurance premiums to your estate.
Heirs can request up to two 90-day extensions to sell or refinance the property. To receive approval for the extension, they must prove that they are arranging the financing to keep the house or that they have it listed for sale.
If the property value exceeds the loan balance, it makes sense for the heirs to sell the home and keep the surplus proceeds after paying off and discharging the HECM.
But what if the opposite happens and the loan balance exceeds the property value? As long as the reverse mortgage is a HECM, your heirs can simply turn the home over to the lender, which fully satisfies the loan repayment obligation. The lender sells the property and the government's insurance takes care of any shortfall. Alternatively, your heirs can choose to keep the property by paying the lender 95 percent of the appraised value.
If the reverse mortgage is not a HECM, the estate or heirs may be on the hook for the shortfall. Liability depends on the terms of the loan — private reverse mortgages can have terms that would be illegal for HECM loans.
Borrowers who want to leave the home free and clear to their heirs can accomplish this by purchasing life insurance policies that will pay off the loan balance upon their deaths. The executor of the estate cashes in the policy when the time comes, and uses its proceeds to pay off the reverse mortgage, leaving heirs with a mortgage-free property.
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