Which Reverse Mortgage Option Do I Choose?

October 20, 2003, Revised February 26, 2008

Borrowers taking out a Home Equity Conversion Mortgage have to decide whether to take a credit line, an annuity for varying periods, or a combination of the two. they must also elect between mortgages on which the rate adjusts monthly, and mortgages on which the rate adjusts annually.

Credit Line Versus Annuity Versus Combination

"I am 75 and plan to take out a Home Equity Conversion Mortgage. My problem is that I keep vacillating between the different options. One day I think I want the credit line, the next day I think I want something else. Can you help?"

I can’t give you any specific advice because I don’t know your life plans. I can give you a piece of general advice, however, which is not to agonize about your choice because it is not irrevocable. You can change the option at any time, provided you aren’t maxed out. What that means will become clear shortly.

Under FHA’s Home Equity Conversion Mortgage (HECM) program, you choose from 5 payment plans, which are designed to meet diverse needs. All of them require that you maintain the property as your principal residence.

Line of Credit: You may make withdrawals at times and in amounts selected by you, not to exceed a specified maximum draw.

Monthly Payments:
    Term: You receive payments for a period selected by you.
    Tenure: You receive payments for as long as you remain in the house.

    Line of credit plus term.
    Line of credit plus tenure.

Assuming your house is worth $100,000 and the interest rate is 6%, your credit line would be about $58,400. It grows every month at a rate equal to the interest rate plus the 0.5% mortgage insurance premium. If you didn’t draw during the first year, for example, the line at year-end would be $61,900.

You could also withdraw $58,400 immediately, but if you did, you would be maxed out. You could draw no more funds under the contract.

If you elect a monthly payment only, you could draw about $1250 a month for 5 years, or $720 for 10 years, or $475 for as long as you live in the house. You could also select any combination of credit line and monthly payment, e.g., you might take $10,000 under the credit line combined with $1050 a month for 5 years, or $610 for 10 years, or $400 for as long as you live in the house.

Where the credit line provides maximum flexibility, monthly payment options provide discipline and convenience. You commit yourself, although not irrevocably, to using up your credit line over a specified period.

If you elect to take $1250 a month for 5 years, for example, the entire initial line of $58,400 is set aside for this purpose. So long as you are on this path, you can’t draw any more funds. If you go the full 5 years, you are maxed out. The only way you can draw more is by refinancing, see Can a HECM Be Refinanced?

But you can change your mind before the period is over. If you do, the portion of your line that is unused at that point becomes available for a new plan, which could be a different monthly payment or a credit line. After one year of drawing $1250, for example, $46,480 of your line would remain unused and available.

If at the outset you had elected to receive $450 for as long as you live in the house, at the end of one year the unused portion of your line would be $56,200. You used less than in the previous example, so more is available.

Indeed, you can fully husband your credit line by drawing an amount equal to its growth. This would be about $275 a month. If you drew that amount, your line would remain at $58,400.

What HECM Borrowers Do

Most HECM borrowers take the credit line, and they use a sizeable chunk of it right away. They pay off debts, fund overdue maintenance, and treat themselves, perhaps to a long-deferred vacation or the like. They may use the balance of the credit line to fund a monthly payment, but more often they hold it as a reserve against unexpected costs that can’t easily be covered by their existing budgets. This approach makes perfectly good sense.

On the other hand, monthly payment plans are extremely convenient, especially considering that if need be, they can be converted to credit lines at any time. Perhaps most reverse mortgage borrowers to date have preferred credit lines because they have had urgent financial needs. As reverse mortgages gain increasing acceptability and more homeowners take them to enrich their lives rather than to relieve financial distress, more of them may opt for monthly payment plans.

Selecting the Interest Rate

There is a second decision borrowers must make on a HECM, which is whether to take a rate that adjusts monthly or one that adjusts annually. For a good discussion of this issue, see AARP.

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