Estate Planning Newsletter
Converting a Home Into a Source of Income: Reverse Mortgages
Many are familiar with the concept of a mortgage, where an individual makes monthly payments to a lender. However, for those who qualify, there is another type of mortgage called a “reverse mortgage” (RM), where the lender makes payments to the individual. The homeowner, in effect, borrows against the equity in the home, and interest on the loan is charged.
Reasons to Consider a Reverse Mortgage
Later in life, when income tends to dwindle, RMs can allow a homeowner to convert a home into a stream of income, line of credit or lump sum payment, while the owner continues to live in the home and, more importantly, still retains title to the home even after the equity has been completely exhausted.
Qualifications for a Reverse Mortgage
To qualify for an RM loan, an individual must, in general:
- Be at least 62 years of age
- Apply for RM on the individual’s primary residence (the individual may also own other properties)
- Live in the primary residence for at least one month each year
- Own the home free and clear, or owe only a small remaining mortgage balance
- Own a single-family home, condo, duplex, triplex, fourplex (the individual must live in one of the units), or certain qualifying types of permanent mobile home
In addition, RMs must usually be “first” mortgages, or in other words, they must be the primary debt against the home. Otherwise eligible homeowners still owing money on their property must either pay off the old debt before receiving an RM or pay the existing debt with the money received from the RM.
Different Types of Reverse Mortgages
Generally, there are three types of RMs which differ in their costs and terms:
FHA-insured RM
This RM is backed by the Federal government. Payment options include a monthly loan advance, a line of credit, or a combination of both for as long as the recipient lives in the home or for the duration of a specified fixed term. Extra costs of this RM might include closing costs, insurance premiums, and monthly service fees. Interest rates are charged at adjusting rates on the loan balance. This RM may provide smaller loan advances than the other types of RMs, but guarantees that payments will continue even if the lender defaults.
Lender-insured RM
This RM is backed by a private lender. Payment options include a monthly loan advance or monthly loan advance plus a line of credit for as long as the recipient lives in the home. Extra costs might include mortgage insurance premiums (fixed or variable) and other loan fees. Interest rates might be fixed or adjustable. This RM may provide higher loan advances and allow an individual to mortgage less than full value of the home (which leaves some equity for future use), but the associated costs might be higher than the other types of RMs and payment security of depends on the financial strength of the lender.
Uninsured
This RM differs from the other two types of RMs in that it provides monthly loan advances for a fixed term which is selected when the loan is first taken out. The balance is due on payment of the last loan. Interest rates are fixed and there are no insurance premiums.
FHA insured RMs are available in all fifty states. However, the availability of other types of RMs may vary by state. For example, states such as Alaska, South Dakota and Texas do not offer uninsured RMs. For this reason, it is important to examine local state laws regarding applicable provisions and restrictions on RMs.
Responsibilities and Cautions if a Reverse Mortgage is Granted
If an RM is granted, there are certain requirements and responsibilities that must be met. Since the owner continues to retain title to the property, the owner, not the lender, is usually responsible for taxes, repairs, and maintenance to the property.
Caution in obtaining an RM is necessary, as there can be unfavorable consequences. If the RM is a fixed-term loan and the homeowner cannot pay at the end of the term, the homeowner faces foreclosure. Also, if the owner dies, the lender often does not take title to the home, but the owner’s estate or heirs must pay off the loan. The Federal Truth in Lending Act requires the lender to inform the homeowner about terms and costs, so the papers for such a loan should be reviewed carefully by the homeowner and/or an attorney, before signing. The homeowner has three days to reconsider the decision to borrow and may cancel the loan (in writing) within that time frame.
Alternatives to a Reverse Mortgage
For “house-rich and cash-poor” senior homeowners, the RM provides dependable income. However, for those who plan to move in a few years, or that already have a substantial mortgage on their home, the RM may not be the best choice. Also, for individuals that want to pass their home to their heirs, the RM is not a favorable option since the lender may receive most of the equity when the home is sold. In these cases, eligible homeowners may wish to consider the following RM alternatives:
- State and local programs that help with real estate taxes or home repairs – allow for deferment of property tax payments or provide for home repairs
- Qualified personal residence trusts – allow homeowners to keep the home for a period of time with title eventually passing to the beneficiaries of the trust
- Sale-leasebacks – allow homeowners to sell home to children, paying them fair market rental value while continuing to live in the home
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