Reverse Mortgages

Reverse Mortgages

Seniors facing potential retirement income shortfalls while having substantial equity in a home or condominium. When this situationprevails, the clients may wish to explore the opportunity of obtaining additional retirement cash through a reverse mortgage.

For many seniors their most valuable asset is their home. Therefore, may want to consider reverse mortgages. They allow seniors over age 62 to enter into a type of loan that converts part of their home equity into tax-free income.

Reverse mortgages can provide a source of income for seniors who own their homes but no other significant sources of income.

House-Rich and Cash-Poor

For many seniors their most valuable asset is their home. More than 50 percent of Americans over age 65 own homes free and clear, while an additional 25 percent have considerable equity. Thus, seniors may find themselves house-rich and cash-poor.

Recently, programs have become available that enable retirees to use the equity in their homes to supplement income. Home equity conversion plans (reverse mortgages) are relatively new in the United States, although they have been available in Europe for many years. In his article “Reverse Mortgages: A New Source of Income,” author Michelle Graves, CSA, writes

The reverse mortgage has evolved into a sophisticated financial planning tool that enables seniors to stay in their homes, or age in a place, and maintain or improve their standard of living without taking on a monthly mortgage payment (Graves, 2000).

Why “Reverse”?

The reverse mortgage allows individuals and couples over age 62 having substantial equity in a home to enter into a type of loan that converts part of their home equity into tax-free income. The amount of money available from a reverse mortgage will depend on the type of reverse mortgage, the age of the borrower, prevailing interest rates, and the condition of the home. The use of projected life expectancies in deterring annuity amounts means that older borrowers usually receive larger monthly payments or lines of credit.

With a traditional mortgage, the homeowner makes mortgage payments and builds equity in the home. When the loan is paid off, the borrower owns the home. A reverse mortgage indeed reverses that process. Homeowners give up equity in exchange for payments that are generally used to provide or supplement retirement income. In a reverse mortgage, the senior homeowner receives money from a lender, again, with the home as collateral. The money may be received as a lump sum, in a series of monthly payments for life, over a specified period of time, or as a flat or increasing line of credit to be used as needed. The homeowner makes no monthly payments on the reverse mortgage.

Loan Repayment

The reverse mortgage must be repaid when the senior moves, dies, or sells the house. According to Graves:

One question that often arises is, “What happens when the borrower dies?” The lender does not “get” the home when the loan matures. The borrower’s estate or family must pay back the loan at that time, with or without a sale of the home. Under many reverse mortgage arrangements, the family virtually has the right to first refusal when it comes to purchasing the home and continuing the family homestead. If the home is sold and the sale proceeds exceed the repayment obligation, the excess funds go to the borrower’s estate. If the sale proceeds are less than the amount owed, the shortfall is not the responsibility of the borrower’s estate.

Reverse mortgage lenders generally make loans in amounts less than the full value of the home. In general, the repayment obligation of the borrower’s estate can’t exceed the value of the property. Borrowers may be able to preserve some equity for heirs by basing the cash advance on only a portion of the home equity. Typically, borrowers can’t be forced to sell their homes to repay a reverse mortgage as long as they occupy the home, even if the total of the monthly payments to the borrower exceeds the value of the home.

Qualifying for a Reverse Mortgage

A reverse mortgage is generally available when all the owners of a particular home are at least 62 years old. For the federally insured Home Equity Conversion Mortgage (HECM), the home must be a single-family dwelling or a federally approved condominium. For Fannie Mae’s Home Keeper mortgage, the property must be a single-family home or condominium.

Cost of Reverse Mortgages

A number of costs are associated with establishing a reverse mortgage. Many are those typically associated with traditional mortgages and include interest changes, origination fees, title searches, inspections, and the like. Although total costs between the HECM and Home Keeper programs may vary substantially, most cost items do not vary among the specific lending institutions that ultimately provide the reverse mortgage financing. When selecting the appropriate program for a given senior client, a financial planner should compare the total annual loan cost among the various arrangements.

Impact on Taxes and Entitlement Programs

Payments from reverse mortgages generally are not treated as taxable income. Nor do reverse mortgage distributions reduce Social Security or Medicare benefits. However, payments from reverse mortgages may jeopardize a retiree’s eligibility for Medicaid benefits or SSI Disability benefits.

Reverse Mortgage Lending Sources

The United States Department of Housing and Urban Development (HUD) and Fannie Mae administer the largest programs in reverse mortgages. HUD’s HECM is available through private lenders. It is insured by the Federal Housing Authority (FHA) and is fully described on AARP’s Web site. Fannie Mae, the largest investor in reverse mortgages, has two products: Home Keeper Reverse Mortgage and Home Keeper for Home Purchase. HUD’s product has been available since 1987, and Fannie Maes were established in 1989.

The information above is reprinted from Working with Seniors: Health, Financial and Social Issues with permission from Society of Certified Senior Advisors® . Copyright © 2009. All rights reserved.