Going Forward with Reverse Mortgages: The Benefits and Pitfalls of Borrowing against Your Home
EXECUTIVE SUMMARY * Increased life expectancy has caused the elderly to need more funds after retiring, especially if they elect early retirement. The home is often the most valuable asset an individual owns. * Reverse mortgages allow homeowners to continue to live in their homes while borrowing against the equity. A reverse mortgage may provide a lump-sum advance, a line of credit and/or periodic advances. Monthly advances may be received as long as the homeowner lives in the home. Best of all, the homeowner never needs to make a mortgage payment. * A lump-sum advance from a reverse mortgage may be used to pay off the existing first mortgage and eliminate the monthly mortgage payment, reducing monthly cash requirements. * Caution is required because reverse mortgages can be prohibitively expensive unless the homeowner has a substantial amount of home equity, plans to convert all or most of the equity into retirement funding and lives in the home and benefits from the reverse mortgage for the long term. * A homeowner who allows reverse mortgage payments to in crease checking or savings balances beyond certain limits may lose government benefits. ********** Reverse mortgages were created in 1987 by the Department of Housing and Urban Development (HUD) to provide greater financial security to American homeowners age 62 and older. With the aging population in the United States and the rapid appreciation of residential property, the reverse mortgage industry is destined to continue to grow. Reverse mortgages often are thought of as the solution for elderly citizens who need additional funds; however, they can be a costly solution and should be used with caution. This article will help CPAs recognize situations where reverse mortgages can provide much-needed supplementary retirement income--and equally important, when they should be avoided. WHAT ARE REVERSE MORTGAGES? A reverse mortgage is a loan against home equity that requires no repayment as long as the owner continues to live in the home. An HECM (see box below) must be a first mortgage, which means any existing mortgage debt must be paid off first, possibly with some of the reverse mortgage funds. This reverse mortgage provides a line of credit, one or more lump-sum advances and/or a series of periodic advances that may continue until the last surviving borrower leaves the home permanently Reverse mortgage debt increases over time as a result of advances to the homeowner that increase the principal, and the accumulation of service fees and accrued interest. The reverse mortgage debt does not become due until the house is sold or the homeowner(s) move out permanently At that time the lender likely will receive payment of the loan balance through the sale of the home, though in order to keep the house in the family, the homeowner or family members may choose to pay off the mortgage with other funds. If the sales proceeds are insufficient to pay off the mortgage, the shortfall is covered by mortgage insurance, which is required with an HECM. Sale proceeds in excess of the debt go to the homeowner(s) or the estate. REVERSE MORTGAGE LIMITS Since the homeowner is not expected to make payments on a reverse mortgage, no minimum income level is needed to qualify for the loan. The borrower's health and credit rating also are irrelevant. The amount of debt that may be incurred is based on the value of the home, the age of the homeowner and expected interest rates. An older taxpayer can qualify for larger monthly advances and/or a larger lump-sum advance because of the shorter life expectancy over which the loan balance will grow (see exhibit 2). Lower interest rates also allow greater borrowing because there will be less accrued interest. The impact of age on borrowing capacity is seen in exhibit 2 with a $250,000 home, where mortgage rates are 6%. Exhibit 1 Reverse Mortgage Meets Needs of Elderly Joe Homeowner is 85 years old and his wife Jan is 84. …