Reverse Mortgages: A Golden Ticket or Mistake for Your Client?
Several decades ago, a French attorney, Andre-Francois Raffray, had a bright idea: He offered to pay 90-year-old Jeanne Calment the equivalent of $500 a month in return for the gift of Calment’s apartment upon her death. Calment lived to 122, outlasting Raffray, who died at the age of 77. She was still paid the $500 a month until her death in 1997, receiving a total of about $180,000, which was two to three times the value of the apartment.
The agreement between Calment and Raffray can be seen as a crude predecessor to today’s reverse mortgages. Like that agreement, a reverse mortgage allows a person to borrow against the equity of his or her house for either a lump sum or monthly payments. In turn, at the borrower’s death, the lender—usually a bank or the federal government—gets the amount of loan, plus interest and costs, up to the full value of the house. Unlike the simple agreement between Calment and Raffray, reverse mortgages can have high fees and might not work out as well for the borrower or his or her heirs as it did for Calment. To determine whether a reverse mortgage might be appropriate for a client, it is helpful to understand how reverse mortgages work, their benefits, and their disadvantages.
What Are Reverse Mortgages?
In a reverse mortgage, a person borrows against the equity of his or her home, or in some cases, other dwellings owned by the borrower, for a lump sum amount, monthly payments, or a combination of the two. The payment is not taxable as income, but might be considered a liquid asset, and thus included in calculations relating to Medicaid, if the funds are kept in an account past the month received. There are two types of reverse mortgages. Ninety-five percent fall into the category of Home Equity Conversion Mortgages (HECMs), which are administered by the Department of Housing and Urban Development and insured by the Federal Housing Administration. The remaining 5 percent are proprietary reverse mortgages, which are offered by banks, credit unions, or other financial institutions for people with very high-value homes. To qualify for either type of reverse mortgage, the borrower typically has to be at least 62 years old. The older the person, the higher amount available to borrow. The current lending limit for HECM loans is $625,000. The borrower must have sufficient equity in the home, though the loan can be used to pay off the borrower’s existing mortgage. The lender will have to confirm that the house is in sufficient repair. For HECM loans, the borrower will have to attend counseling with a HUD approved counselor to ensure the borrower knows the risks and costs of the loan.
After obtaining the loan, the borrower will be required to keep current on the taxes and insurance for the house. The loan becomes due when the borrower dies or no longer lives at the house. At that point, the borrower (if still alive) can pay back the loan, an heir can pay back the loan, or the house will be sold with the proceeds first going to the bank to cover the loan.
What Are the Advantages to Reverse Mortgages?
- The loan is limited to the value of the home if the borrower dies or decides to move away, even if the home decreases in value.
- As long as the borrower stays current on the taxes and insurance and keeps the house in good repair, he or she will not be forced to move.
- If there is an existing mortgage on the property, the proceeds of the reverse mortgage can be used to pay the first mortgage off. Then, the borrower will have more available cash each month. The borrower can stay in the home even if he or she would not otherwise have enough money to pay for the mortgage.
- Interest rates are usually lower than for a standard home equity mortgage.
- The buyer will not need to show that he or she has sufficient wages to get the loan.
What Are the Disadvantages to Reverse Mortgages?
- While the costs can be financed into the loan, the costs are rather expensive compared to a standard home equity loan. While the fees can vary, they usually include: (1) a mortgage insurance fee (2 percent of home’s value); (2) origination fee (capped at 2 percent for the first $100,000, and 1 percent thereafter, with an overall cap of $6,000); (3) title insurance; (4) a monthly service fee to maintain the loan (usually $25-$35 a month); (4) title, attorney, accounting, and recording fees; (5) the cost of the appraisal; and (6) a survey (if needed).
- The borrower can use up all of the equity in the home, which decreases the amount of inheritance or the amount of assets available to the borrower if he or she needs to be moved into assisted living or a nursing home.
- If the borrower lives in a nursing home or assisted living for more than a year, he or she will have to repay the entire loan.
- If family members live in the house with the borrower, but are not on title, then they will have to pay the loan or be forced to move.
- The interest rates can be adjustable, and thus alter the amount of equity borrowed.
While reverse mortgages likely will not be as lucrative for today’s borrowers as the agreement was for Jeanne Calment, they can be an optimal way for many clients to continue living in their homes while also affording the increasing costs of care, food, and other daily expenses. On the other hand, reverse mortgages can place an unnecessary financial burden on the borrower and his or her heirs. Given the costs and risks, careful consideration, planning, and discussion with family members should occur before signing the papers.
Additional information on reverse mortgages can be found online at:Paul M. Crisalli is an attorney with The Lawless Partnership, LLP, a small firm in Seattle, Washington, where his practice focuses on estate planning, real estate, litigation, and appeals. Contact him at email@example.com.
© Copyright 2010, American Bar Association.