Definition and Examples of Reverse Mortgage Line of Credit
A reverse mortgage line of credit allows retired homeowners to access the equity in their homes without making monthly payments as you do with other products like a home equity line of credit (HELOC). The most common reverse mortgage line of credit is a home equity conversion mortgage (HECM) that is used as a line of credit.
With a reverse mortgage, the borrower is not required to make payments, and the balance can accrue until it is paid off when the house is sold either by the borrower or their heirs. The line of credit means that funding works similarly to a credit card in that the borrower can withdraw funds, up to their credit limit, as they need. Also like with a credit card, the balance can be paid down to free up that amount for future borrowing.
Reverse mortgage lines of credit are only for those over age 62. So, let’s say you are older than 62 and fully own your home, which is worth $400,000. You could apply for an HECM to start a $250,000 reverse mortgage line of credit. If approved, you’d be able to withdraw part of the $250,000 balance when needed and interest would only accrue on the active balance.
How Reverse Mortgage Line of Credit Works
The HECM program is insured by the Federal Housing Administration (FHA). It is the only reverse mortgage that the federal government insures. You can apply for an HECM through an FHA-approved lender, which includes most medium- to large-sized banks.
There are also private options, but the lack of federal insurance on those loans may incentivize the bank to charge more in fees or interest to balance the risk. The federal insurance also guarantees the home value at the time of the loan, so your heirs won’t be required to pay more than the property value.
Before you can apply for an HECM, you are required to meet with a counselor. The counselor will explain how the loan works, all associated costs, alternatives, and discuss your financial situation. You can find counselors on the Department of Housing and Urban Development’s website.
The lender will have the house appraised, and verify that you meet the requirements for an HECM. The lender also has to underwrite whether you’re willing and able to make normal house expenses, such as maintenance, property taxes, and insurance. The lender may require that part of the loan funds be set aside for these types of expenses.
Once you’re approved, you can choose between several payment options, including single disbursement, monthly payments for a specified term, and the line of credit.
Take care to understand the costs associated with HECMs. Reverse mortgages typically have higher interest rates than normal mortgages. They also have several costs, including loan origination fees, mortgage counseling fees, closing costs, mortgage and homeowners insurance premiums, loan servicing fees, and other normal expenses such as property tax.
If you choose to use a line of credit, you can generally withdraw up to 60% of the loan amount in the first year. Interest then accrues on the loan balance, and you can pay down the principal balance if you want to free up credit and lower the accruing interest.
Requirements for Reverse Mortgage Line of Credit
Here are the federal requirements for the borrower of an HECM reverse mortgage line of credit:
- Age 62 years or older
- Must have a considerable amount of equity in home
- Property must be considered the borrower's principal residence
- Borrower cannot have any delinquent federal debt
- Borrower must be financially capable of paying ongoing expenses such as property tax, insurance, and maintenance; the lender will use a credit history, income and personal balance sheet analysis, and historical payments of taxes and insurance to underwrite this requirement.
- Borrower must participate in an information session with a HUD-approved counselor
Property types that are accepted as collateral for an HECM include:
- Single-family residence or two-to four-unit home
- HUD-approved condo
- Condo units that meet FHA single-unit requirements
- Manufactured home that meets FHA requirements
Reverse Mortgage Line of Credit vs. Home Equity Line of Credit
A home equity line of credit (HELOC) is a line of credit that uses the equity in your home as collateral. Unlike HECMs, HELOCs can be acquired on any home that you own, even if it isn’t your primary residence. There are no age requirements for HELOCs.
HELOCs are revolving lines of credit, like a credit card, which means the principal balance of the loan must eventually be paid off. Typically, you will have access to the line of credit for a set period of time, making only interest payments. Then, during the repayment period, you will pay both principal and interest.
Because HELOCs have required payments, the lender will underwrite the loan based on both the collateral value (like with a reverse mortgage) and the borrower’s ability to make the loan payments.
The other key difference between HELOCs and HECMs is cost. HELOCs may have closing costs and origination fees like HECMs, but the interest rate is usually lower. Other associated costs are either not required in HELOC origination or have immaterial costs.
HECMs have higher initial costs, which are often charged to the loan, but no required payments. HELOCs have lower initial costs, but they require monthly payments. Your personal situation will ultimately determine which loan product may be right for you.
- Reverse mortgage lines of credit allow seniors to access the equity in their residence without having to move or make loan payments.
- With a line of credit, the borrower only accrues interest on the balance.
- HELOCs are similar to reverse mortgages, but are underwritten on borrower repayment ability and have lower fees.
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