The government-insured reverse mortgage program has undergone major changes in the last few years to better protect borrowers, including one that limits how much money borrowers can get in the first year of the loan.
- Less money?
- How limited is access to your own home equity?
- Why is limiting how much money you can a good thing? Does it help the borrowers?
You might not be made of money, but your house IS! Find out how much you can get with a reverse mortgage.
A reverse mortgage is a loan that enables homeowners aged 62 or older to borrow against the equity in their home without having to sell the home, give up title, or take on a monthly mortgage payment. The home equity conversion mortgage (HECM) is the most common type of reverse mortgage, and is administered through a program under the U.S. Department of Housing and Urban Development.
The government determines how much borrowers are eligible for based on their age, home value and interest rate.
But regardless of how much you are eligible to borrow, the amount of loan proceeds you can access during the first 12 months after closing is limited to 60 percent of the loan amount.
For example, if you are eligible for a $100,000 reverse mortgage, you may only access $60,000. At the beginning of the 13th month, you may access as much or as little of the remaining loan proceeds as you wish.
“The limitations on the first-year draw amount are a great benefit to the consumer,” says Brian Cook, mortgage advisor and reverse mortgage specialist at Federal Way, Wash.-based Alpine Mortgage Planning.
It may sound like a disadvantage, but there are significant benefits to only being able to access part of your loan in the first year.
Prior to the 60% draw limit, borrowers could draw 100% of the principal limit in the first year, which led to problems for some borrowers down the road.
“The goal of the reverse mortgage is to provide financing and help people stay in their home,” Cook says. “But some people were using it to buy that truck or go on that vacation they always wanted without thinking about their financial strategy long term. After all of that equity has been used there is nothing left. People who took out all the funds upfront no longer had the reverse mortgage as a revenue stream for other expenses as they aged.”
The limit helps insure that you will have money for a longer period of time. The benefits of limiting available cash in the first year include:
Better money management: The first-year draw limit helps borrowers to manage their mortgage better, especially younger borrowers who have more years than the average borrower to plan for, Cook says.
“The limit allows borrowers to see how their finances are acting, and then they can decide a year from when they initiate the loan whether they need the rest of that money now or later,” Cook says.
Opportunity for increased funds: If taken out as a line of credit, funds become more substantial the longer they are left untouched, providing a significant revenue stream in your later years.
Observing the mandatory 60% limitation on draws helps grow your funds should you take out your reverse mortgage as a line of credit.
When receiving a reverse mortgage, borrowers can opt for a fixed-rate or adjustable-rate HECM.
Fixed-rate HECM: Loan borrowers will receive the cash in a lump sum, and the rate is set and fixed for the full duration of the loan.
Adjustable-rate HECM: Loan borrowers can select one option or a combination of payment methods, including as a line of credit.
Taking out a line of credit is one of the most popular ways a reverse mortgage is used, Cook says.
The line of credit features unscheduled payments or installments, meaning you can take out funds at any time and in the amount of your choosing (subject to a first-year cap and the overall principal limit—or total amount that can be borrowed) until the line of credit is exhausted. You may also make payments back toward the line of credit.
The amount available to the borrower in the reverse mortgage line of credit increases every month by a pre-determined amount, based on the previous month’s credit line balance and the current interest rate.
But there are exceptions to the 60 percent rule.
You can withdraw more funds if there is an existing mortgage, or other liens, on the property, says the National Reverse Mortgage Lenders Association (NRMLA).
“The reverse mortgage can be the only mortgage on the property, so all existing debts secured by the home must be paid off,” NRMLA says. “You can withdraw enough to pay off the mortgage, plus another 10% of the maximum allowable amount. On a $100,000 reverse mortgage, that’s an extra $10,000.”
There are significant pros and cons to reverse mortgages. However, if you wish to stay in your home and you need money or are just interested in having extra money available, then a reverse mortgage can be an excellent opportunity.