How Does a Reverse Mortgage Line of Credit Work?

A man reviewing information about his reverse mortgage line of credit

A reverse mortgage line of credit has some unique features that distinguish it from the more widely understood home equity line of credit (HELOC). Both financial vehicles allow homeowners to tap equity. But that’s where their similarities end. Using a HELOC as a jumping-off point, let’s look at the unique advantages that a reverse mortgage line of credit offers.

Reverse Line of Credit Versus a Home Equity Line of Credit

A home equity line of credit is a short-term loan with a fixed draw period, usually 5-10 years. Homeowners approved for a HELOC can tap the funds at any time, similar to how they might use a credit card. Available funds decrease as credit use increases. Also, like a credit card, the lender who extends the HELOC can cancel or revoke it for various reasons. A line of credit in a home equity conversion mortgage (HECM), works a bit differently.

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How a Reverse Mortgage Line of Credit Works

As with a HELOC, there is no requirement that reverse mortgage borrowers use the line of credit. And interest only accrues on withdrawn funds. 

However, unlike a HELOC, which has a fixed amount of available credit, a HECM line of credit can grow over time. As the principal limit grows over time, as long as the loan has not matured or the borrower has not defaulted, the homeowner’s line of credit borrowing power increases . All money borrowed from the line of credit accrues on the loan balance.

Because the U.S. Department of Housing and Urban Development (HUD) guarantees HECMs, lenders cannot freeze a reverse mortgage line of credit if the home drops in value. 

When the borrower takes the reverse mortgage, they may elect to take equity out as cash. They may also keep it available for the future as a line of credit. Or they may choose a combination of the two. The amount available through the line of credit depends on the amount of available equity and how much the borrower chooses to take as cash payments.  

For instance, take a HECM borrower eligible to take $100,000 (after fees) of equity out of their home. Say this borrower elects to take a payout of $50,000 cash and reserve $50,000 as a line of credit. That borrower will have access to an available line of credit of $50,000 on day one of the loan.

A HECM Line of Credit Grows Over Time 

A unique feature of a reverse line of credit is that it grows over time. This growth occurs at the same rate as the interest plus the annual mortgage insurance premium (MIP) charged to the loan (0.50% of the principal). Even if the borrower’s home depreciates, the mortgage line of credit will continue to grow at the same rate. 

Using the example above, on day one of the loan, that borrower will have a $50,000 line of credit. However, that available $50,000 will immediately increase at the interest rate applied to the principal plus the ongoing mortgage insurance premium rate. The borrower will start the next month with an increased loan balance and a higher line of credit. 

What Is the Mortgage Insurance Premium (MIP)?

Homeowners with federally insured HECM loans pay mortgage insurance premiums or MIPs that allow the Federal Housing Authority to insure these loans. HECM borrowers pay an upfront MIP of 2% of the home value, and an annual MIP which is 0.50% of the loan amount. This fee is added to the balance of the loan.

How Do You Take Out a Reverse Mortgage Line of Credit?  

Getting a reverse mortgage line of credit is not a complicated process. A borrower has four payout options: a lump sum, monthly payments, a line of credit, or a combination. The homeowner chooses how they will receive their funds between loan approval and closing. If the borrower selects a line of credit, the funds are available to the borrower as needed. 

Are Borrowers Required to Get a Line of Credit?  

There is no requirement that a reverse mortgage has a line of credit attached to it. However, with a unique growth structure and the fact that they cannot be canceled due to a decrease in home value, these lines of credit can offer a safety net that borrowers may or may not ever need to access. They also allow older homeowners to leverage home equity while protecting other investment sources.  

With these and any other financial vehicles, it is always wise to enlist the services of a qualified financial advisor.