What is a reverse mortgage?
By now, most seniors have heard about reverse mortgages. The term was coined because this arrangement is the exact reverse of a regular mortgage. Instead of you paying the mortgage company “ they pay you tax free cash. This is a federal government sponsored program that has NO credit requirements and is designed to keep seniors in their homes. The Federal Government is fully aware that the cost of nursing homes on taxpayers is enormous. These loans are available to any homeowner where the youngest spouse is 62 or older.
The most important feature of a reverse mortgage is that is does not have to be paid back until the senior (and spouse if applicable) moves out, sells the home, or dies. The money received can be used for any purpose like modifications, home health care or other services. Although 24 hour nursing care is extremely expensive, some seniors and their families may find this option more attractive that moving into a nursing home or selling the home to pay for a nursing home.
There are a few variations in reverse mortgages, but in all cases the main point that needs to be made is that the senior does not have to make any payments while they are in the home and they cannot be kicked out of their home. There are significant fees associate with reverse mortgages that are tacked on to the loan. These fees must be considered before a decision is made to obtain a reverse mortgage.
Generally a reverse mortgage makes approximately 50% of the home equity (up to a limit) available as a lump sum, credit line or a monthly payout. The amount available varies based on the areas of the country and the age of the youngest homeowner. If there any loans outstanding they must be paid off out of the proceeds of the reverse mortgage. The fees associated with a reverse mortgage are much higher that a traditional mortgage or home equity loan. The interest that accrues on a reverse mortgage is payable if the homeowner moves out or dies. It is important to note that the estate DOES NOT have to pay for any deficiency that may arise if the home sells for less than the loan balance. The loan must be paid off within twelve months of the death of the last homeowner or twelve months after the last homeowner moves out.
Some seniors may opt for a simple home equity loan because the fees are lower and they can borrow up to 80% of the home™s value. The disadvantage of a HELOC (home equity line of credit) as they are called is that there are income and credit requirements and the possibility of foreclosure which is not present with a reverse mortgage. The following is a sample scenario.
Homeowners John and Mary are 72 and 74, have a $200,000 home and no liens. They create a reverse mortgage and receive $100,000 in cash, or a credit line to draw against. The current interest rate is approximately 5.6%. The interest is calculated and compounded only on the amounts withdrawn. If the homeowners decide to take the entire amount, the interest will begin to accrue on the $100,000 plus another $15,000 in fees. Therefore the beginning balance will be $115,000. In theory, the interest that accrues should track the appreciation on the home since home prices tend to go up with inflation. Of course no one can predict the future so it is possible that the homeowner will be spending their children’s inheritance. The consumption of inheritance is rarely a factor when a reverse mortgage is the only option to free up cash that is needed and otherwise dormant as home equity.
Medicaid and Medicare Considerations
The cash generated by a reverse mortgage has no impact on Medicare eligibility, but does have an impact Medicaid eligibility “ if the loan is taken as a lump sum and not spent. Although Medicaid is prohibited from looking at home equity provided one spouse is still living in the home or a child under the age of 21. Once that equity is converted to cash it is counted as an asset. If Medicaid eligibility is an issue it is better to draw out only what it needed and spent.
Myths
There are 7 common myths about reverse mortgages:
- A reverse mortgage sells the home to the lender
- Heirs will not inherit the home
- The homeowner could get forced out of the home
- You could outlive the reverse mortgage
- The homeowner pays taxes on a reverse mortgage
- There are large out-of-pocket expenses
- A reverse mortgage is similar to a home equity loan
We have already covered some of these myths in brief, here is a more detailed explanation:
1. A reverse mortgage sells the home to the bank
False: The lender does not take title to the home. There may be companies offering such an arrangement but they should be avoided. Lenders are guaranteed their money by the government. The homeowner keeps the title to the home in their name. What the lender does is add a lien onto the title for the amount that is borrowed so that the lender can guarantee that it will eventually get paid back the money it lends.
2. Heirs will not inherit the home
The estate inherits the home as usual but there will be a lien on the title for the balance of the reverse mortgage. The balance is whatever proceeds were received from the reverse mortgage plus interest.
For example, let’s assume someone takes out a reverse mortgage and owes $100,000 (with accrued interest) after 5 years. Then the homeowner passes away and the estate sells the house for $250,000. The lender gets $100,000 and the estate inherits $200,000.
A reverse mortgage is a non-recourse loan which means the only asset guaranteeing the loan is the property itself. If the property value is less than the balance of the reverse mortgage, the lender can not request other assets from the estate and must make an insurance claim for the loss to the FHA.
3. The homeowner could get forced out of the home
The FHA reverse mortgage was created specifically to allow seniors to live in their home for the rest of their lives. Because the homeowner receives payments from a reverse mortgage instead of making payments to a lender, the homeowner can never be evicted or foreclosed on for non-payment. However, it is the homeowner’s responsibility to maintain the home in good condition, keep property insurance current, and pay the property taxes.
4. Someone can outlive a reverse mortgage
The reverse mortgage becomes due when all homeowners have permanently moved out of the property or passed away. There is no time limit.
5. The homeowner pays taxes on a reverse mortgage
The proceeds from a reverse mortgage are not considered income and are not taxable. Furthermore, the interest on reverse mortgage is tax deductible when it is repaid.
6. There are large out-of-pocket expenses
Typically the only out-of-pocket expenses are the cost of the counseling and the appraisal. If requested, many lenders will agree to pay the appraisal fee upfront and finance the cost into the loan.
7. A reverse mortgage is similar to a home equity loan
The only similarity between a reverse mortgage and a home equity loan is that both use the home’s equity as collateral.
- Any homeowner can apply for a home equity loan. A homeowner must be age 62 to apply for a reverse mortgage.
- A home equity loan must be repaid in monthly payments over 5 or 10 years. A reverse mortgage is not paid back until the homeowner moves out of the property or passes away.
- A home equity loan requires stable income and a solid credit score. A reverse mortgage does not consider income or credit.
- A home equity loan charges no closing costs but has a higher interest rate over the life of the loan. A reverse mortgage charges upfront closing costs but has lower interest over the course of the loan.
In conclusion, a reverse mortgage has some tremendous advantages. The homeowner considering a reverse mortgage must get a firm quote explaining all fees and go through mandatory counseling (about an hour). They should also consult their children or family member. The children should keep in mind that this cash infusion may reduce or eliminate the possibility that they may wind up providing financial support to their parents. A full proposal will show all fees and an annual project showing the increase in the annual loan balance. Although there is nothing to stop a homeowner from paying the loan off, them still must amortize the fees over a long enough time period to make the arrangement sensible.
One last note: A reverse mortgage can be used to purchase a new home, it does not have to be on an existing home.
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