You have probably watched or heard an advertisement on television or radio for reverse mortgages. These ads are hard to miss as they seem to be everywhere, and they make a reverse mortgage sound very attractive for senior citizens living on a modest fixed income. Is a reverse mortgage as good an idea as the ads make them sound? The Carmel estate planning attorneys at Frank & Kraft explain how a reverse mortgage works.
What Is a Reverse Mortgage?
For seniors who have equity in a home, a reverse mortgage allows them to access some of that equity through a loan that uses the home as collateral. Traditionally, a reverse mortgage was used by retirees with limited incomes to cover basic monthly living expenses and/or pay for costly health care by accessing the wealth they built up in their home. Today, however, there are no restriction on how the proceeds of a reverse mortgage can be used. As the name implies, when you take out a reverse mortgage, the bank pays you instead of you paying the bank for the term of the mortgage. You can receive the proceeds from a reverse mortgage in several different ways, including:
- Lump sum – a lump sum of cash at closing.
- Tenure – equal monthly payments as long as the homeowner lives in the home.
- Term – equal monthly payments for a fixed period of time.
- Line of Credit – draw any amount at any time until the line of credit is exhausted.
Imagine, for example, that you and your spouse have lived in your home for over 30 years and you now own your home outright. The home’s current market value is $800,000. Your monthly retirement income is less than you need to live comfortably so you decide to take out a reverse mortgage for $400,000. You could choose to take the entire $400,000 as a lump sum at the closing or you might prefer to receive monthly payments. Once you take out the reverse mortgage, the equity in your home decreases by $400,000 to $400,000 and that $400,000 mortgage loan must eventually be repaid. The actual amount you will be eligible to receive in a reverse mortgage will depend on several factors, including the age of the youngest borrower, current interest rate, appraised value of the home, and government imposed lending limits.
Am I Eligibile For a Reverse Mortgage?
To be eligible for a Home Equity Conversion Mortgage (HECM), which is a reverse mortgage that is insured by the Federal Housing Administration (FHA), the youngest borrower on title must be at least age 62. If the home is not owned free and clear, then any existing mortgage must be paid off using the proceeds from the reverse mortgage loan at the closing. Beyond those two important criteria, there are additional financial eligibility criteria established by HUD that you must meet.
How Do I Repay My Reverse Mortgage?
As a general rule, a reverse mortgage does not become due until the death of the borrower or until the borrower is no longer living in the home as his/her primary residence. Of course you must abide by the terms of the loan by paying the required property taxes, keeping homeowners insurance current and maintaining the home according to Federal Housing Administration requirements.
How Does Taking Out a Reverse Mortgage Impact My Estate Plan?
Keep in mind that taking out a reverse mortgage may have a significant impact on your existing estate plan. If, for instance, you planned to gift your home to your children in your estate plan, that git will be worth considerably less after you take out a reverse mortgage.
At the time of your death or in the event that the home ceases to be your primary residence for more than 12 months, a reverse mortgage loan will usually become due. Consequently, you (or your estate) must either repay the reverse mortgage or put the home up for sale to pay for the mortgage. If the home is sold, and the equity in the home is higher than the balance of the loan, the remaining equity belongs to you or to your estate.
On the other hand, if the sale of the home is not enough to pay off the reverse mortgage, the lender (not the borrower) must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage. This is important because it means that even if the sale of your home, after you are gone, fails to cover the amount owed to the reverse mortgage, your other assets (such as vehicles, investments etc.) are not at risk of being sold to repay the loan.
How Is a Reverse Mortgage Different from a Home Equity Loan?
A reverse mortgage may sound very similar to a home equity loan because both are based on the existing equity in your home; however, there is an important difference. With a Home Equity Line of Credit (HELOC) you must make monthly payments toward repaying the loan whereas with a reverse mortgage you do not. In addition, with a reverse mortgage, any existing mortgage or mandatory obligations must be paid off using the proceeds from the reverse mortgage loan which is not typically a requirement for a home equity loan.
Contact Carmel Estate Planning Attorneys
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about a reverse mortgage and how it might impact your estate plan, contact the experienced Carmel estate planning attorneys at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
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