What it means
A reverse mortgage lets older homeowners borrow against their property and repay only when they sell or leave. The borrower can receive the money as a lump sum, a credit line or regular monthly payments.
Under a term plan, the borrower decides how many months the payments should last, for example ten years. A shorter period means a larger monthly payment, and a longer period means a smaller one.
The plan suits people who need extra income for a known stretch, such as the years before a pension starts or while paying for care. The attraction is a bigger monthly cheque than a tenure plan, which pays smaller amounts for as long as the borrower stays in the home.
The drawback is the cliff at the end. If the borrower lives longer than the chosen term, the payments stop while living costs continue, so the choice of term needs careful thought.
As with any reverse mortgage, the debt grows over time, because each payment, the interest and the fees are added to the balance. The homeowner keeps living in the property, but the equity left for the family falls as the balance rises.
Choosing the term involves a trade-off between income now and the amount of equity left later. A shorter term gives more cash each month, but ends sooner, while a longer term spreads the same borrowing power over more years.
Many advisers suggest running both options through a calculator and testing what happens if the borrower lives longer than expected.
In practice
Real-world examples.
Example
A 66-year-old homeowner retires before her pension can be claimed and takes a five-year term plan. The monthly payment replaces her lost salary until the pension begins. She then stops borrowing and lives on her pension. She keeps a note of the date the payments stop so that she can plan ahead.
Example
A man in his seventies needs to fund home improvements and private nursing care for eight years. His adviser sets up a term plan for 96 months. The payments cover the bills and the house stays in the family until it is sold. The payments are timed to match the period when the costs are highest.
Example
A couple compares a tenure plan paying $700 a month with a 12-year term plan paying $1,600 a month. They choose the term plan because they want a higher income early in retirement. They plan to review their finances before the term ends. They agree to revisit the decision with their adviser every year.
Formula
Calculation
Total payments received = monthly payment x number of months
A borrower chooses a term plan of $1,500 a month for 10 years.
Number of months = 10 x 12 = 120
Total payments received = 1,500 x 120 = $180,000
If the loan charges a combined 6% a year on the balance, interest in the first month is on a balance of $1,500, which is 1,500 x 0.06 / 12 = $7.50. The monthly interest grows as the balance rises, so the total owed at the end is well above $180,000.
Rule of thumb: monthly payment = amount available / number of months, before interest and fees. For example, $144,000 spread over 120 months gives $1,200 a month.Case study
Seen in the real world.
Elmstead Advisory is an illustrative, fictional firm that helps older homeowners release equity. A client, Mrs Oyelaran, owned a house worth $350,000 and wanted extra income for ten years until she could sell and move into a retirement village.
The adviser set up a term plan paying $1,200 a month for 120 months, a total of $144,000 before interest. She showed Mrs Oyelaran a table of how the balance would grow, so the final repayment would not be a surprise.
Mrs Oyelaran sold the house in year nine, repaid the loan from the proceeds and kept the rest. The illustrative lesson is that a term plan works well when there is a clear exit plan that matches the period chosen. Mrs Oyelaran also kept a reserve of $10,000 in a savings account, so that an unexpected bill in the last year of the plan would not force her to sell early.
Watch out
Common mistakes.
- Picking a term that is too short and then having to live on much less once payments end. The choice depends on whether the priority is a larger income for a fixed period or a smaller income for as long as possible.
- Forgetting that interest and fees are added each month, so the debt is larger than the total payments received. Ask the lender for a projection of the balance each year.
- Assuming the loan is repaid when the term ends, when it normally stays due until a later trigger such as sale or death. Repayment is usually triggered by events such as a sale, a permanent move or death, not by the end of the payment term.
Questions
People also ask.
How is a term plan different from a tenure plan?
A term plan pays more for a fixed period, while a tenure plan pays less for as long as the borrower lives in the home.
Can the term be changed later?
Sometimes, but it depends on the lender and the loan rules, and a fee may apply. Lenders may charge a fee, and the rules differ between loan types.
What happens if the borrower moves out?
The loan usually becomes due, and it is repaid from the sale of the property or other funds.
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