There are six methods for receiving reverse mortgage proceeds under a HECM. Because the HECM is one of the most common reverse mortgages by far, we will have a particular focus on them here. Those six options for receiving reverse mortgage proceeds are:
- Lump sum
- Tenure payments
- Term payments
- Line of credit
- Tenure payments plus a line of credit
- Term payments plus a line of credit
In this section, we’re going to walk through and explain each of the options. Let’s start with the lump sum.
For those who would like a fixed-rate payment plan, the only option they have is a single-disbursement lump sum payment. This means that, for the life of the reverse mortgage, the interest rate will never vary. If the homeowner were to choose this option, they will then receive a large amount in the form of a lump sum as soon as their reverse mortgage closes. This is a good choice for those who would use the loan to pay off a high mortgage balance or another large expense, or simply want to take most or all of the proceeds at once.
Fixed-Rate Payment Plan
Drawbacks to the Fixed-Rate Payment Plan
There are drawbacks to this payment plan, however. Because the homeowner would receive a lump sum, they cannot receive any additional proceeds from the loan. This makes the lump sum payment plan a bad idea for anyone who can’t manage their money well or can be tempted to squander their money. Some reverse mortgage scammers work hard to convince unwitting seniors to choose this payment plan, or target borrowers who’ve recently chosen it. We will cover common reverse mortgage scams in the next module.
The biggest drawback might lie in how much the borrower can receive. The homeowner can only borrow 60% of the initial principal limit in the first twelve months of the loan. For example, if a borrower were to receive $300,000 over time with another payment plan, they would only receive $180,000 (60%) with a lump sum. The other 40% stays in their home equity, and they can’t ever borrow against it.
While this could be a serious issue for some, it can be a help to others. If the homeowner would like to keep the option of paying off the reverse mortgage in the future, the remaining home equity will make that more of a possibility. There is also the option of the borrower changing their payment plan to borrow the remaining 40%, but doing this might result in receiving less than expected due to the rising of interest rates since they took out the loan.
Interest will still accrue on that amount, as well as on the ongoing monthly mortgage insurance premium and any financed closing costs until the reverse mortgage is due and payable. In this payment plan, the initial interest rate is higher than other plans, but the expected interest rate over time is lower.
Adjustable-Rate Payment Plans
The other five payment plans each have adjustable rates. If a homeowner were to choose one of those payment plans, they then have three possibilities for how their interest rate can change:
- The interest rate will adjust once a year based on the Constant Maturity Treasury (CMT) index, plus a margin established by the lender.
- The rate is not allowed to increase by more than 2% a year, and it cannot increase (or decrease) by more than 5% from the initial rate over the term of the loan
- The interest rate will adjust monthly based on the CMT index, plus a margin established by the lender
- The rate is not allowed to increase more than 10% over the term of the loan, and there is no limit to how low the interest rate can go
- The interest rate will adjust monthly based on the London Interbank Offered Rate plus a margin established by the lender
- This rate is not allowed to increase by more than 10% over the term of the loan, and there is no limit to how low the interest rate can go
These three options matter because they affect how much interest the loan accrues over time. However, it doesn’t affect the borrower in terms of their scheduled monthly payments or their available line of credit. If interest gets particularly high, it does affect the home’s equity, and means that the homeowner will receive less if they end up deciding to sell the home.
In the case of a borrower wishing to remain in their home for the rest of their lifetime, the interest rates rising may not be as much of a concern. For borrowers who do wish to sell their home, make sure that they know to stick to the lower interest rates, such as the first option above where the interest rate cannot exceed 5% from the initial rate of the loan. It is your job as the loan officer to ensure that the homeowner understands how interest rates affect their situation.
In an adjustable interest rate plan, the payment plan options available will use an expected interest rate. This means that the lender will make an educated guess at what the adjustable interest rate will average out to over the term of the loan. This is one of the key factors in determining how much a homeowner can borrow, beside their age and the property’s value.
This is an option where the borrower receives equal monthly payments for as long as they live in their home as a primary residence. The interest for the tenure payment plan accrues on monthly payments as the homeowner gets them, as well as on any financed closing cost – including the up front mortgage insurance premium and any ongoing monthly mortgage premiums. The following are what the borrower owes when the reverse mortgage becomes due and payable:
- Monthly tenure payments
- Closing costs
- Mortgage insurance premiums
Compared to the lump sum (fixed-rate) payment plan, the tenure payment plan has a lower initial interest rate, and its total interest cost over the term of the loan could be less as well because of that lower starting rate. However, depending on how long the homeowner remains in the home and how the rate adjusts over time, it could end up costing more.
The big draw to the tenure payment plan is the ability for a senior to continue to live in their home, without many worries about interest rate or managing a large sum in their account. Tenure payments offer a stability and predictability, so the borrower can expect a steady stream of proceeds for the term of the loan. However, if a borrower needs to pay off a large expense right away, this is not an option for them. Instead, they should opt for the lump sum, or a combination tenure and line of credit payment plan.
Advantages of Tenure Payment Plans
Under the tenure payment plan, payments are figured assuming the borrower will live to be 100. If they happen to live past 100, they will still receive payments for life under this plan. If the homeowner’s life expectancy is shorter, then the term payment plan (covered next) might be the best option for them, as they will receive monthly payments for a specific number of years, allowing them to receive higher payments.
If there is only one borrower on the reverse mortgage, and that borrower dies, then the surviving homeowner will not receive any further payments from the tenure plan. However, if both homeowners are on listed the payment plan, the surviving borrower will still receive the same payments even after the other borrower dies.
If you are advising anyone to choose the tenure option, make sure that they are aware of what can happen when only one homeowner is on the reverse mortgage. This has been a problem for some families, where payments unexpectedly stop when the borrower passes away. It’s the loan officer’s responsibility to ensure they are well informed and can avoid any unnecessary issues.
This payment plan is very similar to the tenure payment plan, except that the equal monthly proceeds paid to the borrower occur only for a set period of time. The term plan has an adjustable interest rate, and it changes as market interest rates do. Interest will accrue on each monthly payment the borrower receives, as well as on any financed closing costs. Those closing costs can be an origination fee, up front mortgage insurance premiums, third-party fees, and the ongoing monthly mortgage insurance premiums. Just like the tenure plan, the following are what the borrower owes when the reverse mortgage becomes due and payable:
- Monthly tenure payments
- Closing costs
- Mortgage insurance premiums
The term payment plan will be a good choice for someone who either knows or has a good idea of how long they will be staying in their home. For example, if a senior is planning to spend the next ten years in their home, and then move into an assisted living facility, this could be the best option for them. Because the loan will end at a set time, the monthly payments are larger compared to the tenure plan.
This might not be the best plan for someone who doesn’t have any other assets or income, however. Once the term of the loan ends, there will be no way to gain additional proceeds from the home. If this happens, the homeowner can still remain in their home after the end of the payment period, as long as they continue to meet all of the conditions, like paying the property taxes, homeowners insurance, and general repairs.
Just like the tenure plan, if only one borrower is on the reverse mortgage and they die, then the other homeowner will not receive any more payments, because they are not the borrower. Make sure that the seniors you work with know all of the facts, as this scenario has caused problems for some families where an older spouse took out a reverse mortgage in their name alone.
Adjustable-Rate Payment Plans
Line of Credit
This payment plan allows the homeowner to borrow funds only as needed. It takes the homeowner’s age, the home’s appraised value, and the loan’s interest rate into account, and creates an initial principal limit (the total amount the homeowner can borrow) based on that information. In the first twelve month period, the homeowner can borrow up to 60% of this amount, and in the years that follow they can access the remaining credit line. This credit line increases slightly each month, based on the loans’ interest rate and the unused amount of the credit line.
This is a great option for homeowners who have other methods of regular income, because the borrower can simply use the line of credit when they might need it. A big plus to this payment option is its flexibility, and how it allows the borrower to access as large or as small an amount as they might need. There is no requirement to borrow a minimum per month, and lenders are not allowed to require it.
One of the most alluring aspects of this method is that it can act as a combination of all three of the previously mentioned methods (lump sum, tenure, and term), depending on the homeowner’s needs at any given time. They are in control of when and how they borrow money.
This line of credit cannot be revoked, even if the housing market were to change or if the homeowner’s financial situation were to take a bad turn. However, the borrower must continue to meet all of the conditions of their loan. For instance, if they stop paying their property tax or homeowners insurance, the amount that they have borrowed could be called due and payable.
If a homeowner is smart with their money, and uses the line of credit sparingly, they will have much more equity available should they need it in the future compared to other payment plans. While the line of credit option might seem like the best one due to its flexibility and the control it offers the homeowner, there are some drawbacks. The initial costs, such as the up front mortgage insurance, origination fee, and other closing costs will cost the borrower thousands, and they will still have to pay interest on these costs from the start if they’re financed.
Another negative is that, if a homeowner isn’t wise with their money, they could end up using everything within 366 days of closing the loan. If they borrow the initial 60% maximum in their first year, and then the remaining 40% on the first day of the second year, then they would not be able to access any other proceeds from the reverse mortgage.
Tenure Payments Plus a Line of Credit
More officially known as a modified tenure plan, this option is a combination of the tenure payment plan and the line-of-credit plan. The borrower gets fixed monthly payments as well as access to a line of credit as long as they live in their home as a principal residence. Compared to a straight tenure plan or line-of-credit plan, the monthly proceeds and the credit line will be smaller, but they will have access to the same total amount of funds.
The borrower still retains some flexibility in establishing their monthly payments as well as choosing the size of their credit line, but they must balance out. This means that, if a borrower would like a larger credit line to draw on, their monthly payments will be smaller as a result. This plan also allows the homeowner to borrow just what they need, which can be helpful if they aren’t able to handle their money like they used to. With this modified plan, there is less risk of depleting all of their equity, in case they might want to move in the future, and keeps interest expenses down. If a borrower requires a large amount of money right away, this is not the plan for them.
Term Payments Plus a Line of Credit
Also known as a modified term plan, this plan (as you might have guessed) is a combination of the term payment plan and the line-of-credit payment plan. The borrower receives a fixed monthly payment for a set number of months, as well as access to a line of credit for as long as they live in their home as their primary residence. Like the modified tenure plan, the monthly payments and line of credit will be smaller than they would be in an uncombined plan. The borrower will still have access to the same amount of funds.
The borrower has some flexibility, both in choosing the size of their credit line and in establishing the size of their monthly payments and when they will get them. Just like the uncombined term plan, the monthly payments will be larger than any monthly payments in a tenure plan, assuming they both have the same size credit line.
When the loan term is up, the homeowner will still have access to their loan proceeds if they haven’t exhausted their line of credit. Like the modified tenure plan, this plan will allow the borrower to have some equity left over in case they ever want to move, as well as lower the interest charges. However, there is a good chance the homeowner can run out of loan proceeds. If a borrower were to use up their line of credit before they reach the date when the monthly payments stop, they would not have access to any other loan proceeds. A borrower must use their line of credit carefully, ensuring they have enough proceeds for as long as they need it. Again, this is not the plan for those who need a large sum in a hurry.
There’s a reason HECMs are so popular. Their variety of payment plans appeal to every kind of senior, and caters to whatever situation they’re in. As a mortgage loan originator, you can use this to your advantage, but make certain that both you and the consumer know the pros and cons to each payment plan. This way, you’ll be setting everyone up for success.