Some Pros and Cons of Reverse Mortgages

Over the last few years a reverse mortgage has come back into focus, for seniors and those who plan with them. In general, a reverse mortgage converts home equity into cash in several different ways, ranging from monthly payments to an equity line to one-time payouts — or a combination. The amount you can borrow varies according to your age, the value of the home, current interest rates and loan fees.

Are reverse mortgages a good idea? Most news stories imply that they are. Reports suggest reverse mortgages can be a source of ready cash when it’s needed — similar to other investments. But, like anything that impacts your bottom line when your earning potential is limited, taking out a reverse mortgage isn’t a no-brainer. That’s why candidates for these mortgages should consider both the benefits and the drawbacks before jumping in and get good advice from their attorney, accountant and financial planner. The substance of this letter is an introduction to the subject and not intended to be advice to any particular person or situation as they differ depending on the facts and goals of the affected party.

Pros

Reverse mortgages can be a valuable retirement tool when homeowners understand them. Reverse mortgage loan advances are not taxable (verify with your tax adviser), and generally don’t affect your Social Security or Medicare benefits. You retain the title to your home, and you don’t have to make monthly repayments (the Reverse pays off the Borrower’s current mortgage liens, if the Borrower qualifies).

Cons

The loan must be repaid when the last surviving borrower dies, sells the home, permanently leaves the home for 12 months or longer, no longer lives in the home as a principal residence or otherwise as may be provided in the loan agreement and related documents. This can be a negative for Borrowers who become ill and need to permanently move out of their primary residence.

As of now, there is uncertainty about how to treat a non-borrowing spouse who is under 62. Previously, all Borrowers had to be on the loan and title.

The front load is very high. Front-loading refers to upfront costs, paid out of the home’s equity at closing of the reverse mortgage loan. That’s important to consider, especially if you plan to stay in your home for just a short time or borrow a small amount. As with conventional mortgages, reverse mortgage lenders make money the old-fashioned way: through interest, origination fees and points. The interest rate varies according to the market. However, closing costs are significantly higher with reverse mortgages.

Traditional 30-year mortgages also come with high price tags. Older people can find it more difficult to qualify for a mortgage since many retirees no longer work and have limited incomes.

Because you retain title to your home, you are responsible for property taxes, homeowner’s insurance, utilities, fuel, maintenance, HOA fees and other expenses. If you don’t pay those expenses or fail to maintain the condition of your home, your loan may become due and payable. You may also have the added burden of paying for mortgage insurance[1].

Interest on reverse mortgages is not deductible on income tax returns until the loan is paid off in part or whole.

Untapped equity in the home is generally not considered an asset in determining Medicaid eligibility as long as the home is owner-occupied. For a homeowner with property worth more, there’s definitely an argument for obtaining a reverse mortgage and then spending down the cash. But that cash is also subject to Medicaid’s time limitations on asset reduction. You should talk to an eligibility specialist early in the process to see where you stand.

The amount you owe on a reverse mortgage grows over time. Interest is charged on the outstanding balance and added to the amount you owe each month. That means your total debt increases as the loan funds are advanced to you and interest on the loan accrues.

[1] Why would borrowers have to pay mortgage insurance? After all, that insurance is required for regular mortgages if borrowers don’t have a large enough down payment, and its purpose is to protect lenders in the event of a default. With a reverse mortgage, there’s no such risk to lenders. Charges for mortgage insurance premiums are taken up front on the home value – not the amount borrowed, as it is with regular forward mortgages. For example, if you own a $400,000 home, the upfront mortgage insurance premium at 2% would be $8,000 – whether you borrow $30,000 or $200,000.

Written by Attorney David B. Goldstein,dbg@hgplaw.com