Why I’ve Learned to Respect Reverse Mortgages

When you hear the term “Reverse Mortgage”, you may imagine a slick sales scheme peddled by old TV actors (the Fonz!) trying to drum up business and trick seniors into risking title to their homes. And, truth be told, that wasn’t far from the truth until the FHA and HUD changed the rules to protect applicants and enhance the benefits for borrowers.

Reverse Mortgages (RM’s) have been available since 1987. Because of the former high expenses and lack of qualification standards, many seniors who should not have been eligible for these loans were accepted into the system. Some subsequently lost their homes when they ran out of money – as recently as 2014, 12% of RMs were in default. This gave RMs a black eye and led to rejection by Fee-Only financial planners.

Beginning with the Reverse Mortgage Stabilization Act of 2013, however, new regulations have dropped RM costs to as low as $125 for the mandatory consumer counseling fee. New, stricter standards have resulted in a better system for qualifying applicants and a drop in defaults. Now, instead of considering RMs only in the event of financial hardship, advisors are gradually adding them to their toolkit of planning solutions.

Getting a Reverse Mortgage is usually easier than traditional mortgage lending. RMs allow homeowners with significant home equity to borrow against that equity if they meet these requirements:

  • Are age 62+ (other spouse can be younger),
  • Have home equity,
  • Have enough income or assets to pay for future expenses of home ownership,
  • Have undergone a “financial assessment” to verify sustainable income and assets,
  • Live in a home in reasonable repair, necessitating no urgent major maintenance, and
  • Are borrowing for the primary residence. This includes a single-family home, condo, or multiplex with up to four units if one unit is borrower’s primary residence. Certain manufactured homes are also eligible.

Homeowners can borrow up to $625k (FHA), based upon age, current interest rates, and equity in the home. The older the borrower, the more loan she can qualify for.

Proceeds can be taken as –

  • A lump-sum payment,
  • Tenure payments (similar to a lifetime fixed annuity),
  • Term payments (fixed payment for fixed length of time),
  • A line of credit (RMLOC), or
  • Any combination of the above.

A Reverse Mortgage has no requirement for repayment until the homeowner dies or moves to another primary residence, including a nursing home. Otherwise, the homeowner (heirs) can repay the mortgage and accumulated interest at any time.

The homeowner may choose to sell the home. If the selling price is less than the loan balance due, the owner does not have to make up the difference. Borrowers can repay 95% of the home’s appraised value at any time to remove the lien and cancel the mortgage.

What are some ways a Reverse Mortgage could benefit you?

  • Tax planning: since RM proceeds are not taxable, you can take a combination of both IRA and RMLOC withdrawals to remain in a lower tax bracket, reduce Medicare premiums, and lower taxes on areas such as Social Security, Net Investment Income, and Alternative Minimum Taxable Income.
  • Income strategy: you can switch from your IRA for a stream of income to your RMLOC during bear markets and corrections.
  • Estate planning: you can retain ownership of the family home and your heirs will get a stepped-up basis at death. This is particularly useful in high-cost areas such as California where the value has increased, surpassing the $250k exemption allowed to a surviving spouse.
  • Estate and tax planning: in the case of a multi-unit home, you can avoid income taxation on the sale of the units you don’t live in by passing the property through your estate.
  • Quality of life: according to a study of 1,800 adults by NRMLA, 80% of seniors would prefer to live independently in their own homes. 89% of adults with living parents would prefer their parents to live independently in their own homes rather than leaving an inheritance at death. (Of course, a RM doesn’t preclude having both!) A 2015 study by Ohio State University cited that 81% of borrowers were satisfied with their RM results.
  • Cash-flow planning: homeowners are converting a previously illiquid asset to cash flow.
  • Long-term care planning: access to a RMLOC can be substituted for expensive long-term care insurance.
  • Protection from filial laws: 30 states have some version of “filial responsibility” laws on the books requiring adult children to pay medical bills for parents who are unable to pay them.

Of course, there is no single panacea for financial planning, including Reverse Mortgages. You may not be excited about paying a four-figure loan fee or you prefer not to live in a large home for the rest of your life. The goal of entering retirement mortgage-free adds another layer of complexity – even if a Reverse Mortgage makes sense, the thought of taking on debt again may be unbearable. But if you meet the requirements for qualifying, it won’t hurt to consider one.

Your fee-only Certified Financial Planner or CPA can help you analyze whether a RM is right for you. Be sure your advisor is educated on the “new and improved” rules and is open-minded about using them. You can read more about Reverse Mortgages and access RM calculators on my Pinterest page at pinterest.com/FeeOnly4Doctors/reverse-mortgages/.

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