For seniors living on a fixed income, the opportunity to access an additional income source may sound like a dream come true. A reverse mortgage offers just that; however, it is crucial that you understand how a reverse mortgage works and how taking one out might affect your estate plan before you decide to sign on the dotted line. Toward that end, we will explain the basics of a reverse mortgage.
What Is a Reverse Mortgage?
For seniors who have equity in a home, a reverse mortgage allows them to access some of that equity through a loan that uses the home as collateral. Traditionally, a reverse mortgage was used by retirees with limited incomes to cover basic monthly living expenses and/or pay for costly health care by accessing the wealth they built up in their home. Today, however, there are no restrictions on how the proceeds of a reverse mortgage can be used. As the name implies, when you take out a reverse mortgage, the bank pays you instead of you paying the bank for the term of the mortgage. You can receive the proceeds from a reverse mortgage in several different ways, including:
- Lump sum – a lump sum of cash at closing.
- Tenure – equal monthly payments as long as the homeowner lives in the home.
- Term – equal monthly payments for a fixed period of time.
- Line of Credit – draw any amount at any time until the line of credit is exhausted.
How Does a Reverse Mortgage Work?
To better understand how a reverse mortgage works in the real world, let’s imagine that you and your spouse have lived in your home for decades and the home is paid off. The current market value of your home is $600,000. While you are getting by on your retirement income, your monthly budget is tight so you decide to take out a reverse mortgage for $200,000. You could choose to take the entire $200,000 as a lump sum at the closing or you might prefer to receive monthly payments. Keep in mind that once you take out the reverse mortgage, the equity in your home decreases by $200,000 to $400,000. In addition, that $400,000 mortgage loan must eventually be repaid.
What Are the Eligibility Requirements For a Reverse Mortgage?
To be eligible for a Home Equity Conversion Mortgage (HECM), which is a reverse mortgage that is insured by the Federal Housing Administration (FHA), the youngest borrower on title must be at least age 62. If the home is not owned free and clear, then any existing mortgage must be paid off using the proceeds from the reverse mortgage loan at the closing. Beyond those two important criteria, there are additional financial eligibility criteria established by HUD that you must meet. The actual amount you will be eligible to receive in a reverse mortgage will depend on several factors, including the age of the youngest borrower, current interest rate, appraised value of the home, and government-imposed lending limits.
How Is a Reverse Mortgage Repaid?
As a general rule, a reverse mortgage does not become due until the death of the borrower or until the borrower is no longer living in the home as his/her primary residence. Of course, you must abide by the terms of the loan by paying the required property taxes, keeping homeowners insurance current and maintaining the home according to Federal Housing Administration requirements.
A Reverse Mortgage Sounds Like a Home Equity Loan – What’s the Difference?
A reverse mortgage may sound very similar to a home equity loan because both are based on the existing equity in your home; however, there is an important difference. With a Home Equity Line of Credit (HELOC) you must make monthly payments toward repaying the loan whereas with a reverse mortgage you do not. In addition, with a reverse mortgage, any existing mortgage or mandatory obligations must be paid off using the proceeds from the reverse mortgage loan which is not typically a requirement for a home equity loan
A Reverse Mortgage May Impact Your Estate Plan
Make sure you consider all the implications of taking out a reverse mortgage because doing so often impacts an existing estate plan. For example, if you planned to gift your home to your children in your estate plan, that gift will be worth considerably less after you take out a reverse mortgage.
In addition, at the time of your death, the loan will likely become due. Consequently, your estate must either repay the reverse mortgage or put the home up for sale to pay for the mortgage. If the home is sold, and the equity in the home is higher than the balance of the loan, the remaining equity will become part of your estate and be distributed according to the terms of your estate plan. If, however, the sale of the home is not enough to pay off the reverse mortgage because the value of your home has depreciated, for example, the lender (not the borrower) must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage. This is a crucial – and extremely advantageous – aspect of reverse mortgages. Even if the sale of your home fails to cover the amount owed on the reverse mortgage, other assets are not at risk of being sold to repay the loan. Consequently, other gifts made in your estate plan remain safe.
Contact Us
Please download our FREE estate planning checklist. If you have additional questions or concerns about how a reverse mortgage might fit into your retirement plans, or you have any other elder law questions, contact us at the Northern California Center for Estate Planning & Elder Law to find out today by calling (916)-437-3500 or by filling out our online contact form.
Timothy P. Murphy
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