Reverse Mortgages and Estate Planning: What You Need to Know
Reverse mortgages can be a great benefit to seniors whose most valuable asset is often their homes. The tax free funds from the loans can be used for expenses like long-term medical care, providing in-home companions, or just meeting shortfalls in monthly budgets. But how might a reverse mortgage affect your estate planning? After all, just about everyone wants to leave some sort of legacy for their loved ones. If you're considering taking out a reverse mortgage but are concerned about it's possible effect on your estate, the following tips may prove to be helpful.
Reverse Mortgages and Your Estate
The first thing to remember about a reverse mortgage is that it's a loan that must be repaid at some point in time. In many cases, the borrower eventually sells the home, pays off the loan, and is able to keep any proceeds that remain. If the borrower should happen to die while the loan is in place, the house is sold when the estate is settled, with any remaining proceeds going to the heirs. In some families, homes are passed down through the generations. If a reverse mortgage exists on a house that you wish for a family member to inherit, that can be accomplished after your death if funds from your estate or that family member are used to pay off the loan. In cases where the loan balance exceeds the property value, heirs can pay off the loan in full and buy back the house for 95 percent of its property value.
What if the Reverse Mortgage Exceeds the Home's Value?
The amount you can borrow with a reverse mortgage is a percentage of the value of the house. That percentage is determined by the age of the youngest borrower and current interest rates. The older you are, the more you can borrow. What if due to a fluctuating real estate market, you end up owing more than the home's value? Fortunately, government-backed reverse mortgages (the most common type of reverse mortgage) come with mortgage insurance that makes up any shortfall — that means your loan is considered paid in full when you sell the home, even if the proceeds don't cover the entire balance. Keep in mind though that reverse mortgages not backed by the government may not have this benefit.
Paying Off a Reverse Mortgage with Life Insurance
One estate planning strategy involves purchasing a life insurance policy that will pay off the reverse loan when you die. This strategy can serve two purposes: the mortgage lowers the amount of home equity at your death so any applicable estate taxes may also be lower and it also guarantees your heirs a set amount of inheritance in tax-free dollars that aren't affected by an uncertain real estate market. And don't forget that if reverse mortgage funds are used to purchase the insurance, those dollars are tax-free too.
Protecting Heirs from Long Term Medical Costs
It's an unfortunate fact of life that when people reach their senior years, they are more likely to face catastrophic medical issues. Unfortunately, Medicare or supplemental Medicare insurance often don't cover the cost of long term private or nursing home care. That can mean having to dip into retirement savings or estate assets to cover those expenses, which means leaving less for heirs upon your death. Estate planning experts typically recommend a three-legged approach to dealing with these costs — long term care insurance, asset redistribution (in particular, exchanging cash on hand for an annuity, which reduces eligibility-busting assets and provides income for the spouse not entering care) and a reverse mortgage.
Many seniors without high incomes manage to transfer their assets (for example to a spouse) to become eligible for Medicaid for long term residential or in-home care. Requirements differ by state, so check out your options with a local elder law specialist or your state Medical Assistance Office. Homes are generally exempt from consideration, so taking out a reverse mortgage, rather than selling your home and gaining a pile of cash may be the best method of paying for care.
However, if you're considering nursing home care, keep in mind that most reverse mortgage lenders require that the loan be paid off if you leave your home for more than 12 months. In addition, if the home is sold while you're in a nursing home, the amount of cash remaining after the reverse mortgage is paid off could affect Medicaid eligibility.
Increasing the Size of Your Estate
Certain home improvements can potentially increase the value of your home and possibly bring higher profits upon its sale. These types of projects can range from simple makeovers to improve curb appeal to full-blown renovations such as kitchen or bath remodeling. Using reverse mortgages to pay for these improvements rather than a home equity loan can eliminate having to make another monthly payment while on a fixed income. However, care should be taken that the improvements have the potential to increase your home's value as many may not provide a good return on investment. Locals real estate agents can usually tell your what improvements are desirable in your area.
While those remaining in your home after your death might be close family members, if not on the title, the law considers them tenants. That means that if you take out a reverse mortgage that results in the home being sold after you die, they could find themselves out in the street if unable to pay off the loan. Or at least that's the way it is until August 2014 when rules will change for eligible spouses. HUD has announced that beginning on that date and going forward, all HECM loans issued will have a provision allowing spouses of borrowers at the time the loan is taken out who are not also mortgagers at that time, to possibly remain in those homes after the death of such mortgagers. This depends on new and important requirements being met. The length of time eligible spouses will be allowed to remain remains to be determined, but potentially there could be a long "deferral period."
While all of the above suggestions may be helpful in determining how a reverse mortgage could affect your estate, always check with an estate attorney or financial planner to discuss your own unique situation.