How a Reverse Mortgage Line of Credit Works
By: Courtney Jorstad
November 21, 2023 • 7 minute read
One of the top priorities for older homeowners as they enter retirement is making sure that their finances are in order.
As they evaluate what they are receiving from Social Security and their retirement accounts, a reverse mortgage becomes an appealing option because it comes with a lot of flexibility. It allows homeowners to stay in their home for retirement, it doesn’t require monthly mortgage payments, there are no rules about how the money must be used, and there are several ways borrowers can choose to receive their money.
While reverse mortgage borrowers have several options for how they can receive their reverse mortgage funds, the most popular option is the reverse mortgage line of credit.
In this article, we will explore what a reverse mortgage line of credit is, how it works, and who it makes sense for, so you can know if a reverse mortgage line of credit is right for you.
Understanding the Basics of Reverse Mortgages
A reverse mortgage is a type of loan that allows homeowners to access their home equity without having to make any monthly mortgage payments.
The most common type of reverse mortgage is the home equity conversion mortgage (HECM). A HECM reverse mortgage is backed by the federal government through the Federal Housing Administration (FHA) and the U.S. Department of Housing and Urban Development (HUD).
When reverse mortgage borrowers take out a reverse mortgage, the first thing that it will do is pay off the traditional mortgage, if there still is one. Then, the borrower has three options: receive the loan proceeds as a lump sum payment, monthly payments, or a line of credit.
Borrowers may also opt to combine one of those three options if it makes sense for their financial situation.
The amount of money that can be borrowed through a reverse mortgage depends on several factors, including the age of the borrower, the home’s value, and current interest rates.
While reverse mortgage borrowers don’t have to make monthly mortgage payments, homeowners are still responsible for paying property taxes and insurance on the property as well as maintaining the home.
A reverse mortgage loan is paid back when the borrower no longer lives in the home. This can happen if they sell the home, move to a new residence, or pass away.
What is a Reverse Mortgage Line of Credit?
A reverse mortgage line of credit is similar to a traditional home equity line of credit (HELOC), where borrowers can access cash as needed up to a predetermined limit. However, there are some key differences between a reverse mortgage line of credit and a traditional HELOC.
A HELOC is also considered a “second mortgage,” whereas a reverse mortgage replaces your existing mortgage.
With a HELOC, you typically have a “draw period,” which can last from five to 10 years. Once that draw period is over, you are required to make monthly payments on the borrowed amount until it is paid off. In contrast, a reverse mortgage line of credit does not require monthly payments and has no set end date for the draw period.
Another key difference is that with a HELOC, your credit limit can be reduced or revoked at any time by the lender. This does not happen with a reverse mortgage line of credit.
If you opt to receive your reverse mortgage funds as a line of credit, you will be able to start accessing your funds three business days after you sign your closing loan documents.
You are not obligated to use the reverse mortgage funds that are available. The funds will remain available until they are used, no matter how long that may take.
In addition, the unused portion of your available line of credit will grow each month. This means that the untouched funds will increase in value each month at the same rate as your loan’s interest rate, allowing you to potentially access more money.
A reverse mortgage used to be considered a financial tool to turn to as a last resort, but this is no longer the case. Retirement expert Dr. Wade Pfau says that coordinating a reverse mortgage early in retirement as part of a responsible retirement plan “outperforms waiting to open a reverse mortgage as a last resort.”
One of the reasons he gives for this relates to taking the money out as a line of credit because “the principal limit (the overall eligible amount consisting of any loan balance and remaining line of credit) that you can borrow from will continue to grow throughout retirement.”
Who is a Good Candidate for a Reverse Mortgage Line of Credit?
A HECM line of credit may be a good option for those who have the following needs:
Emergency Funds. Having a reverse mortgage line of credit can serve as an emergency fund for unexpected expenses or medical bills.
Long-term care expenses. With the rising costs of long-term care, having access to additional funds through a reverse mortgage line of credit can help cover these expenses.
Home renovations or repairs. A reverse mortgage line of credit can be used to make necessary home improvements without having to take out another loan or use savings.
Delaying Social Security benefits. For those who want to maximize their Social Security benefits by delaying payments, a reverse mortgage line of credit can provide income during that period.
Choosing a Reverse Mortgage Line of Credit
As with anything, there are always pros and cons. The same goes for a reverse mortgage line of credit. Here are the pros and cons of a reverse mortgage line of credit:
Here are some reasons to choose a reverse mortgage line of credit:
Financial Flexibility. A reverse mortgage line of credit provides you with significant financial flexibility. You can choose when and how much money to draw from your credit line, depending on your specific needs and circumstances.
Growth Over Time. The unused portion of a reverse mortgage line of credit grows over time. This growth means you could potentially access more funds in the future than what was initially available at the start of the loan.
Interest Charges. One of the upsides to a reverse mortgage line of credit is that you only pay interest on the money you’ve used. Unlike a traditional mortgage, where interest is charged on the entire loan amount from the beginning until it is paid off, with a reverse mortgage line of credit, you only pay interest on the portion of funds you have actually withdrawn.
No Monthly Payments. With a traditional home equity line of credit (HELOC), borrowers are required to make monthly payments on their outstanding balance. This is not the case with the reverse mortgage line of credit. However, you will still need to pay property taxes, homeowners insurance, and home maintenance costs.
Non-Cancellation. Unlike a traditional HELOC, a reverse mortgage line of credit cannot be reduced, frozen, or revoked by the lender as long as you comply with the loan terms. Reverse mortgage loan terms include living in the property as your primary residence, staying up to date on property taxes and insurance, and keeping the home maintained.
Despite the many advantages of a reverse mortgage line of credit, it’s important to be aware of potential downsides:
Principal Limit Rule. In the first year, the borrowing limit is capped at 60% of your total loan amount. While this is in place to protect the longevity of your loan, it may limit your financial flexibility within the first year. This is true no matter how you decide to receive your reverse mortgage proceeds.
Processing Time. When drawing from your reverse mortgage line of credit, be mindful that the there may be a processing period. This delay might pose challenges for covering immediate expenses.
Adjustable Interest Rates. The only reverse mortgage payment option that comes with a fixed interest rate is the lump sum payment. Both the line of credit and monthly payment methods come with variable interest rates.
Is a Reverse Mortgage Credit Line Right for You?
A reverse mortgage line of credit is a financial tool that offers you the potential for greater financial peace of mind, with features such as no monthly payments, and no risk of cancellation if you adhere to the loan terms.
While there are considerations to take into account, such as the principal limit rule, processing times, and variable interest rates, the benefits could make this a viable option for many homeowners.
As with any financial decision, it’s critical to thoroughly research and consult with a financial advisor to ensure a reverse mortgage line of credit is the right fit for your specific needs and circumstances.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.