October 01, 2016

What to Know Before Adding a Reverse Mortgage to Your Retirement Plan

By Jeffrey A. Asher

The origin of the reverse mortgage is simple: Seniors are generally unable to refinance their mortgage loans because banks are unwilling to offer long-term mortgages to people who may have a short life expectancy. To combat this discrimination, the federal government created the reverse mortgage.

On a basic level, the equity in your home is the difference between its fair market value and the amount of the debt encumbering it. As the value of the home grows, the amount of your equity typically increases. Usually, you can’t touch that equity without being required to pay it back—it’s trapped in the value of the home—unless you actually sell your home.

A reverse mortgage, however, allows you to convert the available equity in your home to cash, which you can use for such things as household expenses, renovations, travel, or to fund your retirement. You can also use the cash from a reverse mortgage to pay for long-term care.

Here’s what you need to know about this financial option.

How the mortgage works

To qualify for a reverse mortgage, at least one owner of a home must be 62 years old or older and reside in the home. Most reverse mortgage contracts allow the homeowner small periods of time living outside of the home (for medical reasons, for example). But once you’ve executed a reverse mortgage, residing outside of the home for a long period of time (a year, for example) will trigger acceleration of the debt.

With a reverse mortgage, you receive a lump sum of money from the lender. The amount you receive is based on the value of the home, the ages of the eligible owners of your home, and current interest rates.

Once you receive the lump sum, you’re under no obligation to make monthly repayments on the debt. Interest on the loan is tacked onto the outstanding balance of the reverse mortgage, which doesn’t have to be repaid until the last eligible homeowner dies, sells, or moves out of the home.

For a homeowner in need of quick cash to finance long-term care, a reverse mortgage may be a great idea. However, if you want to pass on your family home to your loved ones, a reverse mortgage will probably frustrate that intention.

The problem lies in the amount your estate will have to pay back when you die. When that happens, your family has three options:

  • Selling the home, repaying the financial institution, and keeping any net proceeds left from the sale of the home
  • Trying to refinance the reverse mortgage, the feasibility of which will depend on the credit scores and financial wherewithal of those seeking the new mortgage and the financial institution’s willingness to refinance
  • Paying off the reverse mortgage with other assets of your estate

If your family can’t or isn’t willing to take any of those options, they’re likely to see the reverse mortgage foreclosed by the financial institution and the home sold at auction. By that time, there may not be any equity left in the home for them to keep.

The pros and cons

One factor to consider with a reverse mortgage is the rate at which the reverse mortgage grows over time. As noted, interest on the loan is tacked onto the outstanding balance of the reverse mortgage. When the reverse mortgage becomes due—meaning when the last eligible homeowner dies, sells the home, or moves out of the home—the financial institution gets paid the original amount borrowed plus all the accrued interest. The danger occurs when the house value is outstripped by the outstanding balance of the reverse mortgage.

However, reverse mortgages are non-recourse loans. This means homeowners and their estates aren’t responsible for the unpaid balance of the reverse mortgage if there isn’t enough value in the home to satisfy the outstanding balance. So even though you wouldn’t be able to pass your home onto your loved ones if the home isn’t worth enough to satisfy the reverse mortgage, your loved ones wouldn’t be obligated to make the lender whole.

Disadvantages of reverse mortgages include not only the possibility that you won’t be able to pass your home onto loved ones, but also the possibility of a forced sale of the home if you move out, such as to a nursing home or to live with an adult child. The closing costs are also typically higher than normal closing costs on conventional mortgages and home equity loans.

Another factor to consider is that the proceeds from a reverse mortgage are typically offered as a line of credit to be held at a financial institution for your benefit. When you need money from the account, the line of credit would dispense the amount you need.

The advantage of this process is that the money is protected and even invested for you. You also don’t incur interest on the amount borrowed until you actually receive it.

The disadvantage is that you don’t immediately receive your money. Instead, you have to set up a system with the financial institution that allows you to make withdrawals from the line of credit account.

Plus, because the closing costs are paid out of the loan proceeds, you already have a balance due—that’s accruing interest—from day one, even if you never use any of the money from the line of credit account. Many homeowners don’t know this because they weren’t informed by their financial institution that interest is charged on the reverse mortgage proceeds used to pay the closing costs.

Reverse mortgages can also create challenges for government benefit purposes, such as when you need or want Medicaid, for example, to pay for your long-term care. Even for people who have considerable assets or income, depending on the state, Medicaid benefits might be available to pay for long-term care. A reverse mortgage may help qualify you for Medicaid benefits, but only as part of a comprehensive long-term care plan by a qualified attorney.

For most Medicaid applicants and recipients, reverse mortgage proceeds are disregarded as income but counted as a resource if the proceeds from the reverse mortgage are kept beyond the month received. But each state has its own rules when it comes to reverse mortgages and Medicaid benefits.

If you’re looking to include a reverse mortgage in your long-term care plan, it should be done only after you’ve contemplated all the ups and downs and only upon the advice of a qualified attorney.

Jeffrey A. Asher

 Jeffrey A. Asher  is the founder of the Law Offices of Jeffrey A. Asher PLLC in New York City and Westchester County, N.Y., handling estate planning, elder law, probate, estate and trust administration and litigation, Medicaid planning, long-term care planning, and special-needs planning.