A common theme among many elderly people today is “house rich, but cash poor.” In fact, a 1991 study indicated that the average person over the age of 65 had a median income of $15,751 but had average assets of $83,500. Compare this to to the average person between the ages of 45 and 54 whose income was $41,503, but whose total assets were only $57,500. This cash flow problem often makes it difficult for senior citizens to continue to support themselves independently without selling their homes. An unexpected hospital bill or large repair cost can make it virtually impossible. The reverse mortgage is a relatively new tool to help cash-depleted senior citizens keep their homes and remain financially independent. We can advise you on its ramifications.
What Is It?
The reverse mortgage is designed to permit retired persons with limited income to remain in their homes while borrowing against the home’s value. A lender can loan up to 80% of the appraised value of the premises. The loan is not necessarily made in one lump sum, rather, payments are usually made in one of the following ways:
Regular monthly payments for life (also called a tenure loan);
regular monthly payments for a specified term;
a lump sum payment; or
a line of credit approved for immediate disbursement as the individual desires.
The elderly borrower keeps title to the property and cannot be forced to sell or vacate the home if the amount due exceeds the value of the home. Additionally, the borrower makes no payments on the loan unless that is specified in the agreement. Generally, the loan doe not come due until the borrower dies, the house is sold, or a default occurs (such as the recording of a mechanic’s lien or tax lien on the property). When one of these events occurs, the house is sold and the loan is recovered from the sale proceeds. A lender can receive only money from the sale of the house; any other assets of the elderly borrower are protected. You can sell your home at anytime, paying off the balance due on your loan from the proceeds.
Who Qualifies for a Reverse Mortgage?
In order to qualify for a reverse mortgage, the borrower must be 62 years old or older. A certain income, however, is not required. The loan is based only on the equity of the home and the borrower need only demonstrate there is value in the home. The borrower should realize that the property is becoming encumbered and will not be left to the heirs debt free. You will want to discuss this with your heirs and you will want us to re-evaluate your estate and retirement plans.
Types of Reverse Mortgages
There are two different types of loans available. The most basic is the uninsured reverse mortgage. This loan is written for a fixed term from five to ten years. The loan-to-value ratio is generally 80% of the appraised value at the time the mortgage is made. The loan must be paid off at the end of the term or sooner if the borrower dies or sells the property. This type of loan is not for the elderly homeowner who wants the guaranteed right to live in the house until death.
The second program is a loan guaranteed by the Federal Housing Administration (FHA). This lender-insured loan provides monthly loan advances until the borrower dies, sells the home, or reaches the age of 100. This is a nonrecourse loan and neither the borrower nor the borrower’s estate is liable for any amount owed beyond the value of the home. The maximum amount that can be borrowed on on an insured loan is between $67,500 and $124,875, depending on the borrower’s geographic region. The loan limit for a specific borrower is determined by considering the interest rate, the age of the borrower, and certain assumptions about expected future appreciation. This estimate is made by the Department of Housing and Urban Development (HUD). If the borrower outlives the term (surpasses the age of 100), the interest accrues until death, when the house will be sold.
To obtain an FHA-insured reverse mortgage, the HUD program requires counseling, 55 Federal Register 24822 Section 206.41 (1989). When counseling you regarding your reverse mortgage, we consider the following:
Effect on the borrower’s estate. This type of mortgage will deplete what will be left to your heirs. We strongly recommend that you invite your heirs to the counseling session. If there is an adult child in a position to loan the money, we can set up a loan that has the same effect as a reverse mortgage with the child acting as the lender. (We can discuss this option and prepare these documents if desired.)
Maintaining lien property. FHA-insured reverse mortgages require the borrower to maintain first-lien status. Thus, we emphasize that priority must be maintained to avoid the loan being called for a breach. We can explain what you must do to avoid default.
Preparing for maturity of the note and mortgage. A lender may require immediate payment in full when one of the following events occurs: (a) the last borrower dies; (b) a borrower conveys all of his or her title to the property and no other borrower retains title or a long-term leasehold; (c) the property is no longer the borrower’s principal residence; (d) a borrower fails to occupy the property for more than 12 consecutive months because of physical or mental health; or (e) an obligation of the borrower is not performed. We can use planning tools to create an agency to be used to handle the contingencies that might make the loan come due.
Nonrecourse provisions. In FHA-insured reverse mortgages, the note provides that the borrower shall have no personal liability for the payment of the debt regardless of the property value. We will examine your note and mortgage for accuracy and desired elements.
Lender defaults. An FHA-insured reverse mortgage insures both the lender and the borrower from default. If the lender defaults in the lender’s additional advance obligations, HUD will make the payments to the borrower.
Income-tax effect. We will analyze this on a case by case basis.
Effect on public benefits. Again, this varies by borrower and by state.
Alternatives to reverse mortgages. Some other alternatives include: moving to an apartment, retirement community, or a smaller house; borrowing from relatives or a bank; or retaining a life estate.
Drawbacks to a Reverse Mortgage
Although the reverse mortgage can be a tremendously valuable device for an elderly person, its benefits are dependant on the client’s situation. You should be aware that there are substantial fees required to set up the mortgage. These fees include an origination fee, mortgage insurance premiums, a service fee, and other closing costs. Federally-insured loans usually have lower fees.
Additionally, interest rates on reverse mortgages are one or two points higher than on conventional loans and the interest is added to the principal loan balance each month. That means the amount the borrower owes increases significantly with time as the interest compounds. Also, if the borrower is interested in a term loan, he or she should wait as long as possible to convert the equity because the older the borrower is the higher the payments will be. For example, a 65-year old man or woman with $100,000 in equity will receive $234 per month for life, while an 85-year old will receive $604.
Some advisors have said that reverse mortgages should be used as a last resort. However, for the right borrower, they are a viable option. The reverse mortgage allows senior citizens to remain in their homes without losing their independence. The key is to be well informed about all options. Call us today to arrange an appointment and consultation regarding this interesting new concept in retirement planning.