How a Reverse Mortgage Lump Sum Payment Plan Works
By: Courtney Jorstad
November 30, 2023 • 6 minute read
A reverse mortgage can be a practical financial product for older homeowners that can serve as a financial safety net in retirement. It allows older homeowners a way to convert a portion of their home’s equity into cash, providing a source of income while allowing them to remain in their homes.
For many senior homeowners, the standard pension or retirement fund simply may not be enough to meet their daily living expenses, medical costs, or unexpected financial emergencies.
A reverse mortgage can help bridge this gap, offering cash that homeowners can use at their discretion. This may lead to an improved quality of life and a more comfortable and stress-free retirement.
One major decision that reverse mortgage applicants must make is how they wish to receive their funds.
In this article, we will go over one of the three main options—a reverse mortgage lump sum payment—including how it works, reasons to choose this option, and the pros and cons of lump sum disbursements.
What is a Reverse Mortgage and How Does it Work?
A reverse mortgage, formally known as a Home Equity Conversion Mortgage (HECM), is a unique financial instrument. While it has similarities to a conventional mortgage, a home equity loan, and a home equity line of credit (HELOC), there are several differences.
A reverse mortgage loan is solely available to homeowners who have reached the age of 62 or older. A reverse mortgage can only be obtained for the primary residence of the homeowners, which means the homeowners must live in the home for the majority of the year. And potential applicants must also have some equity built up in the home.
Reverse mortgages are regulated by the federal government through the U.S. Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA).
One advantage of a reverse mortgage for those in retirement is that it does not need to be paid back in the form of monthly mortgage payments.
When a homeowner takes out a reverse mortgage loan, the first thing that the reverse mortgage proceeds will go toward is paying off the current traditional mortgage, if there still is one. For the remaining loan proceeds, borrowers can choose from three different ways to receive their money: a lump sum payment, a line of credit, or equal monthly payments.
Borrowers don’t have to choose just one, they can also combine disbursement methods if it makes sense for their financial situation.
Contrary to a common misconception, a reverse mortgage does not equate to selling the home to the bank. The borrowers retain home ownership, which also means that the borrowers must continue to pay the property taxes, homeowner’s insurance, and home maintenance.
The repayment of a reverse mortgage is triggered when the home is sold, it ceases to be the primary residence, or upon the passing of the last remaining borrower.
How Does the Reverse Mortgage Lump Sum Payment Work?
A lump sum payment is a single disbursement of the reverse mortgage funds. When you close on your loan, there will be a three-business-day mandatory waiting period before you can start receiving your funds.
After that period is over, the reverse mortgage lender will deposit the funds into the bank account of your choice.
The amount of money you will receive will depend on several factors: the age of the youngest borrower, the market value of your home, and the current interest rates. Other factors that can have an impact on how much money you will receive are the FHA lending limit and what is known as the principal limit rule.
The FHA puts a limit every year on how much homeowners are able to borrow from a HECM reverse mortgage loan. As of 2024, the FHA lending limit is $1,149,825. However, several reverse mortgage lenders offer jumbo reverse mortgages, which are proprietary reverse mortgages that allow homeowners the ability to borrow more than the FHA lending limit, sometimes up to $4 million.
The principal limit rule is especially important for those considering receiving their money as a lump sum. The principal limit rule says that during the first year of the loan, the maximum amount that borrowers are allowed to receive is 60 percent of their total loan proceeds.
For some, that may be sufficient, but for those who would also like to be able to access the remaining 40 percent, they may want to consider combining the lump sum payment with another payment option such as monthly payments or a line of credit.
Reasons to Choose a Reverse Mortgage Lump Sum Payment Plan
There are several compelling reasons why individuals might opt for a reverse mortgage lump sum payment plan:
- Immediate Access to Funds: This plan allows borrowers to access substantial funds immediately after the mandatory waiting period. This can be particularly useful for those facing significant immediate expenses.
- Funding Major Projects: A lump sum payment can provide the necessary financial means for undertaking major projects, like home renovations, major home repairs, additions, or another large expense. These improvements not only enhance the comfort and functionality of the home but also potentially increase its market value.
- Consumer Debt Consolidation: By receiving a large sum upfront, borrowers can consolidate and pay off consumer debts such as credit cards, car loans, and medical bills.
- Investment Opportunities: Some savvy homeowners may use the money to invest in opportunities that could potentially yield higher returns in the long term. It’s crucial, however, to understand the risks and consult with a financial advisor before proceeding.
- Flexibility: The lump sum payment provides a large degree of financial flexibility. Borrowers can use the funds as they see fit, whether it’s for home improvements, travel, or simply bolstering their retirement savings.
Pros and Cons of a Reverse Mortgage Lump Sum Payment
- Immediate Access to Funds. One of the most significant advantages of a lump sum payment is the immediate access to funds. This can be particularly beneficial for homeowners dealing with urgent financial needs.
- Interest Rates. The lump sum payment option is the only reverse mortgage payment option that comes with a fixed interest rate. All the other payment options come with an adjustable rates.
- Full Control Over Money. A lump sum payment provides homeowners with complete control over their money, enabling them to allocate funds as they see fit.
- One-Time Transaction. Opting for the lump sum means a single, complete transaction, avoiding the need for continuous monthly transactions or the concern of an existing line of credit.
- Principal Limit Rule. Opting for a lump sum payment entails adherence to the 60% principal limit rule, also known as the 60% utilization rule. This means you may receive only up to 60% of the total loan amount initially.
- Potential for Fraud and Abuse. With a substantial sum of money in an account, there may be an increased risk of fraud, abuse, and wastage. This can be a significant concern, especially for vulnerable homeowners.
- Interest Payment. For lump sum borrowers, the complete interest charge is required to be paid at closing. In contrast, for those opting for monthly installments or a line of credit, interest is charged only on the money received, potentially offering a more manageable repayment structure.
Is a Lum-Sum Payment a Good Option for You?
There are several advantages to a reverse mortgage lump sum payment, but there are also some potential pitfalls, depending on individual circumstances. While it offers immediate financial relief and full control over funds, it also carries risks such as adherence to the stringent 60% principal limit rule, potential for fraud, and a sizable interest payment.
If you would like to receive a large chunk of money all at once, but you still want access to the additional 40 percent, you may want to consider combining the lump sum payment with monthly payments or a line of credit.
We always recommend discussing major financial decisions with your financial advisor.
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.