Reverse mortgages should be part of estate planning but too often that's not the case. Instead, they're often placed on the back burner, something to be dealt with at some point in the future.
The tendency to avoid estate planning discussions and home financing stems in part from the reality that such loans are a passive form of finance. Borrowers are not required to make monthly payments for principal and interest. There's generally no repayment urgency and if you're not required to make monthly payments late fees are not a problem.
The catch is that there are now more than 625,000 FHA reverse mortgages outstanding and without exception every one of them will one day end. In fact, a HUD study shows that the typical home equity conversion mortgage or HECM – the flowery terms for an FHA reverse mortgage – is outstanding just six years.
Reverse mortgages end when the borrower moves, sells or passes away. At that point the borrower – or the borrower's spouse or heirs – have important decisions to make.
Let's look at some basic scenarios:
What If the Borrower Moves?
In this case the property has been vacated and the loan automatically terminates. In this situation, the borrower must decide to either pay off the debt or give up the property.
A reverse mortgage is essentially a large negatively-amortizing loan. In other words: Money is paid to the borrower at the start of the loan term. The borrower typically makes no monthly payments for principal and interest. Unpaid interest is added to the loan balance. As an example, you borrow $150,000 at 4.2 percent. At the end of month #1 the interest is $525. For month #2 the debt is $150,525 and the interest cost is $526.84. For month #3 the new balance is $151,051.84. Etc.
For the borrower the decision works like this: Is the mortgage debt plus marketing and closing costs less than the sale value of the property? If yes it makes sense to sell. If no, then give the keys back to the lender.
Because an FHA reverse mortgage is always a non-recourse loan it means that the lender has no claim against the borrower or the borrower's spouse or heirs except for the property. If the lender has a loss on the property the FHA – an insurance program – will pay the lender's claim.
What If the Heirs Want the Property?
In this case the borrower has passed away and the heirs must decide if they want to keep the property. They can pay back the debt or allow the property to be acquired by the lender in exchange for full repayment of the mortgage.
If the house is worth more than the debt, the heirs may want to refinance the property and use the loan proceeds to pay off the reverse mortgage. However, if the value of the property is less than the reverse mortgage debt, the heirs (and anyone else) who wish to purchase the property can do so for 95 percent of its appraised value.
What If There's a Spouse?
FHA-backed reverse mortgages have complex rules regarding spouses. Is there a spouse or a non-spouse? Is the spouse on the mortgage or not? (a spouse not on the mortgage is a non-borrowing spouse or an NBS). If there is a spouse, was he or she a spouse at the time the loan was taken out? Was the loan case number created after August 4, 2014?
Depending on the answers, a spouse or non-spouse may be able to stay – or not stay -- on the property after the passing of a reverse mortgage borrower. For details speak with reverse lenders now.
Reverse Mortgages and Estate Planning
We live in an era where having the right paperwork can preserve estate assets and avoid arguments. To prepare properly it's wise to work with an attorney who specializes in elder law, especially if you have property financed with a reverse mortgage. Because state rules differ the papers you need in one state many not be the same as another. When you speak with an attorney ask about such things as a will, living will, advanced health care directive, HIPAA release forms and a power of attorney. Be sure to make your preferences are known, clear and in writing.