Most reverse mortgages sold today are Home Equity Conversion Mortgages (pronounced “heck ’ems”). The HECM is a government-backed loan program administered by HUD. Unless otherwise noted, the reverse mortgages referred to here are HECMs.
Reverse mortgages can be a great benefit to seniors who need to supplement their monthly income, set up a line of credit for emergencies or obtain a lump sum for larger expenses. However, many homeowners and their families have concerns about the effect a reverse mortgage might have on estate planning. This article addresses some of those concerns.
While heirs may worry that taking a reverse mortgage will lower the value of your estate, it’s a fact that getting money from almost any source does the same thing. Sell the home and downsize? Experts say that selling a home takes ten percent of the price right off the top, and buyer closing costs come to two-to-four percent of the price of the new house. Add in moving expenses and you’ve taken quite a haircut. You’ll be living in a cheaper house, too. If you spend the cash you get from the sale (presumably your reason for selling), you’ll further diminish the estate.
Selling off other assets does the same thing — anything you sell is no longer part of your estate, and anything you borrow must be repaid from its assets. Getting money from family members? Their inheritance remains intact, but their own resources are reduced. They’re out the money today, and there is no guarantee that they’ll get it all back in the future.
While reverse mortgage borrowers don’t make monthly payments, borrowing is obviously taking place, and the loan must eventually be repaid. What usually happens is that either the homeowners, their estate or the reverse mortgage lender sells the property, the loan is repaid from the proceeds, and any remaining money reverts to the homeowners or heirs.
However, in some families, a home may be passed down from generation to generation. What if your heirs don’t want the property to be sold? How can they repay the loan and keep the home?
Lenders must give your heirs at least 30 days after you die to decide what they want to do with the property, and up to six months to arrange financing. If your heirs don’t have sufficient money to repay your HECM, they can purchase the home with a regular mortgage, just like any other buyer, assuming that they can qualify.
A unique feature of reverse mortgages is that it’s open-ended. You don’t know how long you’ll have it or what your loan balance will be. What happens if your balance outstrips your home’s value when the loan comes due?
The HECM is a government-backed home loan, and it comes with mortgage insurance that covers any shortage. This means neither you nor your heirs will be responsible for any remaining balance once the home has been sold. Keep in mind that reverse mortgages not backed by the government may not have this benefit.
What if your heirs want to keep the house? Until recently, reverse mortgage heirs faced a hard decision — either repay the entire balance of the loan, which meant paying more than the property was worth, or return the property to the lender. The lender would then sell it to other buyers, who would not be required to over-pay. This basic unfairness was remedied by HUD in 2011 after the AARP filed a lawsuit on behalf of reverse mortgage heirs. Your heirs can purchase the residence for 95 percent of its appraised value, just like anyone else.
One estate planning strategy involves purchasing a life insurance policy, so your heirs can use the proceeds to repay the reverse loan. This strategy has a couple of advantages: the mortgage balance reduces the amount of home equity at your death, so the estate taxes may also be lower, and it also guarantees your heirs a predetermined amount in tax-free dollars regardless of what happens to housing markets. In addition, if you use reverse mortgage funds to buy the insurance, those dollars are also tax free. The downside is that life insurance gets more expensive as you get older. According to a study by ValuePenguin, the average annual premium for a 65-year old non-smoker with a $250,000 payout is $4,172.
If you and your spouse are both borrowers, the surviving spouse can continue to live in the home. If the payout is a tenure arrangement, providing monthly checks as long as you live in the home, the surviving spouse would continue to receive those checks. If the surviving spouse is not listed as a borrower, he or she would not continue to receive checks, but would be allowed to continue living in the home (the spouses must be married at the time the reverse mortgage commences).
However, other relatives living with you would not have the same protection. Legally, they’d be classified as tenants with no special privileges, and would have to vacate the house unless they could repay the HECM or purchase the property.