If you are a senior, you have undoubtedly seen and/or heard an advertisement for reverse mortgages. If you are also living on a fixed income and wish to enjoy a bit more financial freedom, a reverse mortgage can certainly be tempting. At the same time, it is crucial to have a thorough understanding of how a reverse mortgage works before deciding to accept one. To help you, the Overland Park elder law attorneys at Parman & Easterday explain some reverse mortgage basics.
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 restrictions 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.
How Does a Reverse Mortgage Work?
Often, the best way to understand a concept is by using a real-world example. With that in mind, imagine that you and your spouse have lived in your home for 40 years and you own the home free and clear. The current market value of your home is $400,000. While you are getting by on your retirement income, your monthly budget is tight, prompting you to take out a reverse mortgage for $200,000. You could choose to take the entire $200,000 as a lump sum at the closing or you might prefer to receive monthly payments. Keep in mind that once you take out the reverse mortgage, the equity in your home decreases by $200,000 to $300,000 and the $200,000 mortgage loan must eventually be repaid.
Who Is Eligible 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. 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.
How and When Do I Repay a 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 a Reverse Mortgage Differ 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.
A Reverse Mortgage May Impact Your Estate Plan
Make sure you consider all the implications of taking out a reverse mortgage because doing so often impacts an existing estate plan. For example, if you planned to gift your home to your children in your estate plan, that gift will be worth considerably less after you take out a reverse mortgage.
In addition, at the time of your death, the loan will likely become due. Consequently, 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 will become part of your estate and be distributed according to the terms of your estate plan. If, however, the sale of the home is not enough to pay off the reverse mortgage because the value of your home has depreciated, for example, 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 a crucial – and extremely advantageous – aspect of reverse mortgages. Even if the sale of your home fails to cover the amount owed on the reverse mortgage, other assets are not at risk of being sold to repay the loan. Consequently, other gifts made in your estate plan remain safe.
Contact Overland Park Elder Law Attorneys
For additional information, please join us for an upcoming FREE seminar. If you have additional questions about how a reverse mortgage works, or you have other elder law concerns, contact the experienced Overland Park elder law attorneys at Parman & Easterday by calling 405-843-6100 to schedule your appointment today.