Estate Planning: Pros and Cons of Reverse Mortgages

Tamara Polley
By Tamara Polley June 15, 2014 16:55

Tamara Polley

We’ve all seen or heard advertisements touting reverse mortgages as risk-free sources of ready cash for seniors.

Although I tend to be skeptical of such claims, a reverse mortgage may be a good option in the right circumstances. But homeowners should consider one only after getting all the facts and understanding the advantages and disadvantages.

How does a reverse mortgage work?

To qualify for one, a borrower must be at least 62 and both live at and have equity in the home. He or she takes a loan against the equity – an amount agreed to with the lender– without having to meet credit or income requirements. Also, there are no payments against the loan for the lifetime of the borrower.

The loan may be taken in a lump sum or in fixed payments over a period of time. As payments are received, the owner’s equity in the home decreases and once the total loan amount has been distributed, payments end.

Upon the death of the borrower, the loan balance and all accrued interest become due. Usually, the personal representative of the estate will have six months to sell or refinance the home, although this timeframe can sometimes be extended. As with conventional loans, if the home is sold, the lender will be paid in escrow, and the balance of the sale proceeds will be distributed according to the borrower’s will or trust.

THE CONS:

These loans are expensive. As with conventional mortgages, reverse-mortgage lenders make money through interest, origination fees and points. Interest rates vary according to the market, but reverse-mortgage closing costs are significantly higher than those of conventional mortgages, and the homeowner must also pay for mortgage insurance.

The reverse mortgage is due if the borrower moves. If the borrower becomes ill or for some other reason can no longer live in the home, the reverse mortgage must be paid off or refinanced. Otherwise the home will be sold. This is why it is generally a good idea for both spouses to take out the loan and be mortgage holders. If one spouse then becomes ill and must live elsewhere, the remaining spouse may stay in the home and continue to receive reverse-mortgage payments.

The borrower’s estate is diminished. In my experience, most people holding reverse mortgages have no equity in their homes when they die. An improving real estate market could change this, but heirs should prepare for the worst and understand that there may be no value in the home at their parents’ death.

Payments may limit Medi-Cal eligibility. Home value is not counted in determining if a person qualifies for Medi-Cal. But when equity in the home is converted to cash, reverse-mortgage payments count as a resource. Therefore, a borrower must understand that this income could make him or her ineligible for the state healthcare program – including its long-term care benefits – and plan accordingly.

THE PROS:

Proceeds can pay off existing mortgages. The reverse mortgage can be taken in a lump sum to pay off an existing home loan. Then, as long as the senior lives at home and pays property taxes and insurance, there will be no monthly loan payments.

Loan proceeds are tax free. As the owner presumably paid taxes on the money used to buy the home, there is no second taxation on the cash taken out.

There are no restrictions on spending. Loan proceeds may be spent as the borrower sees fit. I would not suggest using a reverse mortgage for extravagant vacations or to help a grandchild with steep college expenses. But payments could be used for necessary home repairs, to supplement monthly income or to pay for medical care or assistance in the home.

There is no liability beyond the home’s value. Because a reverse mortgage cannot get “upside down,” the heirs will not be liable for more than the home sells for, even if that price is less than the loan’s outstanding balance. If the housing market dropped like it did in 2008, for example, and the reverse-mortgaged home is worth less than the amount owed when the owner dies, the lender cannot come after the heirs for the difference. The lender is limited to what it can get on the sale of the house.

So do your homework: If you are considering a reverse mortgage, get the facts and consult with lawyers, accountants, estate planners and other professional advisors before signing the papers. This way you won’t end up with unpleasant surprises after it’s too late.

Tamara Polley is an attorney with the Sonora law firm of Gianelli & Polley, gianellilaw.com.

Copyright © 2014 Friends and Neighbors Magazine
Tamara Polley
By Tamara Polley June 15, 2014 16:55
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