How to Avoid Outliving Your Reverse Mortgage

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How to Avoid Outliving Your Reverse Mortgage

There are advertisements for reverse mortgages that promise lifetime income. In the proper circumstances, they certainly might be.

However, for clients who don’t fully comprehend this loan product, a key danger is running out of reverse mortgage funds earlier than anticipated.

Here’s a look at how, with each option, you can exhaust your reverse mortgage profits too soon—and how to prevent that from happening.

Key Takeaways

  • The funds from a reverse mortgage may be accessed in six distinct ways.
  • Borrowers are at varied degrees of risk with regard to any reverse mortgage payment arrangement.
  • How fast and easily you might exhaust your capacity to borrow against your house depends depend on the payment plan you choose.

Can You Run Out of Money with a Reverse Mortgage?

The risk that the borrower would utilize the money in a manner that may be advantageous in the near term but detrimental in the long term is present in all loans and lines of credit. The same applies to reverse mortgages.

Before applying for a reverse mortgage, it is ideal that you have a strategy in place for how you will spend the money. However, even if you or a loved one has already taken out a loan, it may still be possible to preserve your equity so that it will still be there when you need it.

1. Single Lump Sum Reverse Mortgage Option

Only the option with a single lump sum payment has a set interest rate. Because you always know how much you will have to repay, taking out a lump sum loan with a fixed interest rate is often a lower-risk option. The hazards associated with this loan arrangement are particular to reverse mortgages.

The lump sum option was deemed potentially dangerous in a study submitted to Congress by the Consumer Financial Protection Bureau (CFPB) back in 2012, particularly for younger borrowers with longer life expectancies who lack alternative retirement savings. Early retirees are at danger of depleting their equity because of the loan arrangement. Seven out of ten borrowers were picking the lump sum option at the time.

Why not go for a lump sum? According to the CFPB, many borrowers have used it to pay off their forward mortgage or other loans so they no longer had to make monthly payments.

However, the bureau also discovered that lump sum reverse mortgage borrowers had an increased risk of defaulting and possibly experiencing a foreclosure because, at some point, they were unable to pay for homeowners insurance, property taxes, or home repairs—all requirements of a reverse mortgage contract.

Borrowers of reverse mortgages who take out a lump amount are also more likely to be defrauded of their profits. The size of the loan makes them a tempting target for thieves—and ungrateful relatives.

2. Reverse Mortgage Line of Credit Payment Plan

A reverse mortgage line of credit is irreversible, as opposed to a home equity line of credit (HELOC). This implies that due to changes in the economy, your financial situation, or the value of your house, the lender cannot cancel or lower it. Unlike a HELOC, where you run the risk of losing access, a reverse mortgage line of credit is secure.

Additional advantages of a reverse mortgage line of credit reduce your danger of running out of money. Whether or whether the value of your house rises, the unused amount of your line of credit increases annually at the same adjustable interest rate that you pay on any money you borrow.

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Additionally, rather of paying interest and mortgage insurance charges on the whole available line of credit, you simply pay them on the amount you borrow. As a consequence, compared to alternative payment options, the sum you owe on your reverse mortgage may increase more gradually.

When you have a reverse mortgage line of credit, you may typically use up to 60% of your total principle amount in the first year. You may withdraw the remaining 40%, plus any funds you didn’t spend in the first year, in the following years.

Of course, if you use up all of your available credit line at once, you won’t have much left over to utilize in subsequent years until you pay back part or all of the money you borrowed, which would raise your principle limit.

3. Term Reverse Mortgage Payment Plan

Equal monthly payments with a set end date are offered via term payment agreements. You have outlived your reverse mortgage proceeds if the period expires before your death.

With a term payment plan, you achieve the principle limit of your loan—the most you are permitted to borrow—at the conclusion of the period. You won’t be able to get any more money from your reverse mortgage after that.

Tip

Refinancing your reverse mortgage to get more money may be a possibility if the value of your house has dramatically grown since you took out your loan. Furthermore, since maximum principle limitations are significantly larger in 2022 than they were in the past, it may be a particularly advantageous alternative if you already hold an older reverse mortgage.

4. Modified Term Reverse Mortgage Payment Plan

Modified term plans provide you access to a line of credit as well as a set monthly payment for a defined number of months. If you choose a straight term plan, both the line of credit and the monthly payment will be less than if you selected a straight line of credit plan.

In a modified term plan, you will only get monthly payments for a certain amount of time, but the credit line will be open until it is all used up. If you utilize your line of credit wisely, you can keep from running out of money using this strategy. You may not have any equity left to draw from at the end of the term if you use up the line of credit too quickly.

5. Tenure Reverse Mortgage Payment Plan

As long as at least one borrower continues to call the property their principal address, tenure payment plans, which have adjustable interest rates and provide equal monthly payments for life, will be in place. Consider the tenure plan, which functions like an annuity, if you’re worried that you’ll outlive the money from your reverse mortgage.

Because of the lifelong income guarantee, your monthly payments will be lower if you apply for a reverse mortgage while you are younger. Those payments may not be sufficient to provide you the financial support you need.

6. Modified Tenure Reverse Mortgage Payment Plan

Modified tenure offers a line of credit in addition to fixed monthly payments for life. Your line of credit will be less than it would be if you had chosen a straight tenure plan, and your monthly payment would be lower.

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Even if you used up your credit limit before the end of your loan’s term, you would still be billed every month for the rest of your life. However, since portion of your home equity goes toward your line of credit, the payments will be lower than they would be under a conventional (not modified) tenure plan.

How to Avoid Running Out of Reverse Mortgage Proceeds

According to the CFPB, retirees who are younger and have longer life expectancies are more likely to use up all of their home equity via reverse mortgages. This isn’t an issue if people can age in place and remain in their houses forever, but it is if they decide or are forced to relocate at a later time.

So, one approach to reduce your odds of outliving the profits may appear to be to put off getting a reverse mortgage as long as you can. You cannot spend reverse mortgage profits that you do not have, and older borrowers are given a higher principle limit than younger borrowers.

Of course, you still have the option to borrow against your house in other ways, use credit cards excessively, or take other actions that might jeopardize your long-term financial security. You can’t protect yourself from careless spending by not having a reverse mortgage.

Reverse mortgage specialists like Wade Pfau and Jack M. Guttentag now believe that the optimum use of a reverse mortgage is to get a reverse mortgage line of credit as soon as you are qualified, leave it alone, and let it grow until you really need the money.

Why not hold off? due to uncertainties around interest rates. Your beginning line of credit will be higher if interest rates are lower when you take out a reverse mortgage. Your credit line will grow at the same pace as rates if they do.

Waiting to apply for a reverse mortgage line of credit might negate the benefit of being able to borrow more money because you are older (and, potentially, because your home is worth more).

Changing Your Current Plan

Talk to your lender about modifying your payment schedule if you have already obtained a reverse mortgage and believe you may be in danger of running out of funds. You may alter your payment schedule as long as you didn’t choose a fixed-rate, lump-sum option and as long as you can remain within your loan’s principal maximum. Compared to refinancing, changing your payment schedule is more easier and costs just a minor administrative charge.

The Non-Borrowing Spouse’s Dilemma

Any payment option you choose will put your younger, non-borrowing spouse at danger of outliving the reverse mortgage profits if you pass away before. Laws that took effect in 2015 prevent qualified non-borrowing spouses from being forced to leave the home in the event that their borrowing spouse dies.

However, following the borrower’s passing, the non-borrowing spouse is not eligible to receive any further payments. Because of this restriction, surviving spouses who are not borrowers may easily outlast the proceeds of a reverse mortgage.

It’s possible for the surviving partner to sell the home and pay off the reverse mortgage. Selling the home, however, could not leave the surviving spouse with enough of a nest egg to live on, depending on how much the property is worth and how big the loan debt is. It could be feasible for the surviving spouse to refinance out of the reverse mortgage if they make enough money to be approved for a conventional mortgage.

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The wisest course of action for the surviving spouse is to remain in the home if the reverse mortgage debt exceeds the value of the property since selling or allowing the lender to go into foreclosure would leave them without a place to live or any money from the home.

If the borrowing spouse passes away first, the non-borrowing spouse should be protected from suffering severe financial hardship due to the loss of reverse mortgage profits.

What happens if I outlive the proceeds from my reverse mortgage?

Unfortunately, you will have to find methods to boost your income—which is improbable in retirement—or lower your costs if you outlive the reverse mortgage’s earnings. If your property has enough equity, you may be able to sell it to pay off your reverse mortgage and use the money to downsize into a smaller, more affordable home.

How do I know which payment option is right for me?

It might be difficult to decide which payment method is appropriate for you; it all depends on your unique scenario. If you are prone to overspending and are worried about having enough money later on in life, when you may not be able to supplement your income, then taking out a fixed-rate lump sum may be a terrible decision for you.

What are some reverse mortgage alternatives?

There are several alternatives to a reverse mortgage. If you can qualify for a refinance, cash-out refinance, home equity line of credit (HELOC), or home equity loan, those all may be better choices. Adjusting your spending habits or downsizing your home can also ensure long-term financial stability into your golden years.

Can I make payments on my reverse mortgage?

Yes, you can make payments on a reverse mortgage to reduce your loan balance during your lifetime, and there’s no prepayment penalty for doing so. Your lender is required to apply any partial repayment first to the interest you owe, then to any loan fees, and last to your principal. However, unlike a forward mortgage, at no time are you required to repay any reverse mortgage principal as long as you meet the contract requirements.

The Bottom Line

A reverse mortgage makes it possible to stay in your home for life even after you have exhausted your home equity. Before you or a loved one takes out this type of loan, it’s important to understand the circumstances under which a reverse mortgage may not provide financial security for life. It’s equally important to understand that with a thorough understanding of how the different payment plans work and how you might prudently use the money, a reverse mortgage can actually help prevent seniors from running out of money in retirement.

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