Every so often, the topic du jour for financial planning is the reverse mortgage, especially when interest rates are low and older people find themselves in need of easily attainable sources of cash.
Reverse mortgages – also known as lifetime mortgages – are completely legitimate; however, seniors and the family members who look after them must understand the tax and estate planning consequences associated with them. There are also below-board companies that prey on seniors, so learning more about these types of loans is very important.
Anyone who is well beyond the average Boomer age probably stayed in one home and opted for a 30-year mortgage. By now, it’s likely that the mortgage is paid in full. With the recession’s long-lasting, detrimental effect on pensions and retirement funds, some older adults might find themselves short of funds that they need for life’s necessities, such as medical care, home repairs and, in some cases, groceries.
The idea of a reverse mortgage might seem desperate, but the allure of securing a loan based on a home’s equity rather than some other kind of collateral with single or lump-sum payments may be just too irresistible. After all, repaying the loan is deferred until the owner dies, the home is sold or the owner leaves.
Reverse Mortgage Basics
In a reverse mortgage, the homeowner makes no payments and interest is added to the lien on the property. If the owner receives monthly payments or a bulk payment of the available equity percentage for their age, then the debt on the property increases each month.
Of course, there are some requirements and rules. Borrowers must be at least 62 years old. The money can be used for any purpose, but the borrower must pay off any existing mortgage with the proceeds from the reverse mortgage and, if needed, additional personal funds.
Some safeguards are in place to protect the uninformed. For example, any borrower must seek third-party financial counseling from a source approved by the Department of Housing and Urban Development to ensure he or she understands all the consequences. The current lending limit is $625,500, no matter how much the home is worth.
Reverse Mortgage Cautions
At first glance, reverse mortgages appear to be an easy way to attain a loan for money that seemingly is already the borrower’s to have. In an AARP survey of borrowers, 93 percent said that their reverse mortgage had a “mostly positive effect” on their lives, compared with 3 percent who said the effect was negative.
Even though the HUD counseling safeguard exists, it’s not difficult to envision some older adults not paying attention to advice at a time of dire financial need. Some borrowers might even suffer from dementia or confusion. As a result, all caregivers must help guide their parents and senior friends to consider all alternatives for money sources.
Compound interest also is a consideration. With a reverse mortgage, there are no monthly payments, so accruing interest is treated as a loan advance. With compound interest, penalties are calculated on the borrower’s principal amount plus interest previously assessed on the loan.
You do the math: the longer the borrower has a reverse mortgage, the higher the chance that any equity increase in the home will be spent before the loan comes due. As a result, borrowers might want to seek out lenders who offer an FHA-insurance Home Equity Conversion Mortgage. In an HECM, the borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to heirs.
As always, it’s best to check with your accountant to review all your options.