Thinking Of A Reverse Mortgage? Here Are Things To Watch Out For And Some Alternatives

With a large group of Americans at or nearing retirement age — and with many of them having inadequate savings to last them through retirement — so-called “reverse mortgages,” wherein a lender converts the equity on a home into monthly payments to the homeowner, are being marketed as a financial cure-all to people wondering how they will be able to afford their golden years. But before anyone dives into the reverse mortgage pool, there are some thing worth pointing out.

First off, what’s rarely mentioned in those advertisements that dominate the basic cable airwaves during the daytime is that, because the loan is tied to the equity in one’s home, it is a finite amount; and not necessarily the endless stream of income it’s touted as. Borrowers need to know before they sign anything that this limited amount of money will suffice for supporting them through the remainder of their years.

And even if there is enough equity in the house to sustain the borrower, they still have financial obligations, like property taxes, homeowners’ insurance and any other fees tied to a HOA or condo association.

If the lender decides that the roof is too leaky or there is a termite infestation — or any number of other possible maintenance-related problems — it can call in the loan. And if you default on that loan, you are now opening up the door to foreclosure.

Instead of going the reverse mortgage route, our cohorts at Consumers Union suggest the following alternatives:

Explore eligibility for less expensive programs or benefits
Reverse mortgages are very expensive loans, and as such, they should be considered only as a last resort. Before considering a reverse mortgage, a senior should first determine if he or she qualifies for less expensive programs that offer monetary assistance or cost-cutting benefits. These programs include Supplemental Security Income (SSI), Medicaid, prescription drug discount programs, energy and telephone discount programs, City and County grants and low-cost home improvement loans (sometimes called “single purpose” loans), state property tax postponement programs, In-Home Supportive Services, and Veterans pensions to pay for in-home care.

Family Financing
Seniors should also consider whether an inter-family loan might be better for their situation. In an inter-family loan, a family member or family members advance money to the senior instead of having a bank do the lending. If a senior has family members who are able and willing to consider such an arrangement, the senior’s home equity can be used as collateral for this “private reverse mortgage” arrangement. The forwarded money, with interest, is tracked and recorded. When it comes time to sell the home, the investors are able to regain their contributions along with the interest it earned.

There are several advantages to inter-family loans over the conventional reverse mortgage. First, the costs associated with family investors are typically a fraction of what they would be from an institutional lender. A successful inter-family loan would mean: 1) the senior can stay in the home; 2) the family investors have a secure loan that produces interest, and 3) when it comes time to sell the home, the senior would have preserved more of the home equity to share with the heirs then they otherwise would have if the senior had gone to a bank for the loan. As a practical matter, it is in the ultimate financial interest of the senior and the would-be heirs to preserve the inheritance rather than having the senior’s home being sold in order to pay back an expensive reverse mortgage loan.

The first step in getting started would be for the senior to talk to his or her adult children and discuss how much money the senior requires. If it is a manageable sum for the would-be investors, then a contract can be drawn up to clarify the terms and to protect those investors. Each investor’s contribution would be tracked on a spreadsheet along with the calculated interest. A senior should contact an estate planning attorney or a Certified Public Accountant to set up the necessary paperwork. The setup costs associated with this would be a small fraction compared to the thousands of dollars required to start a reverse mortgage.

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If you do decide to try a reverse mortgage Consumers Union recommends you first speak face-to-face with a counselor, rather than the more standard phone chat. In fact, only North Carolina requires face-to-face counseling for reverse mortgages. To find counselors in your area, you can go to https://entp.hud.gov/idapp/html/hecm_agency_look.cfm or contact the AARP Foundation at 1-800-209-8085.

In addition to meeting with the HUD-approved counselor, CU recommends you meet with either a Certified Financial Planner or Certified Public Accountant, and/or with an elder law attorney.

Consumers Union has called upon the Consumer Financial Protection Bureau to enact stricter oversight on the reverse mortgage market.

“Reverse mortgages should only be used as a last resort because they can carry huge costs that can quickly drain a homeowners equity,” said Norma Garcia, senior attorney and manager of Consumers Union’s financial services program. “The reverse mortgage industry insists that it can police itself but it’s clear we need common sense oversight by the CFPB to protect seniors.”

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  1. TuxthePenguin says:

    Please, please, PLEASE if you offer to lend money to a family member, write it down and make it as contractual as possible. I’ve seen far too many families tear themselves apart because no one had anything in writing but had a bunch of hard feelings. I recently executed an estate and two brothers ended up nearly in a fist-fight because one owed money to the other and wanted it paid back immediately from his portion of the estate. *sigh* Better yet, don’t lend money to relatives. I’ve heard plenty of people complain how their family member needed money, but “He has five TVs and goes out to dinner all the time!”

    But all of that is better than a reverse mortgage…

    • AtlantaCPA says:

      Good point, I imagine the family financing option mentioned has some contract that goes with it if it’s tracked by a third party. In my own experience I decided to just make it a gift rather than wrangle with the mixed emotions on both sides of a loan.

    • wootbot says:

      I use “Promissory Notes” for this kind of stuff. It’s a simple contract (1 or 2 pages) that legally establishes it as a loan. It completely avoids the danger that when it is paid back the IRS will want to tax you on it as income (even though you already paid tax on the money before you loaned it).

  2. AtlantaCPA says:

    I’d never heard of the ‘family financing’ option, at least not as an officially tracked item. It sounds like a good option as it provides some income without feeling like a handout to the parents. The bad part would be if the kids run into financial issues and start getting behind on those payments, I could see that causing some friction. I imagine knowing your parents are depending on that as income probably makes it the top of the list for what you’ll be paying when money gets tight though.

  3. Loias supports harsher punishments against corporations says:

    So if I understand this correctly:

    Private reverse loan: Family member loans money, uses borrower’s home as collateral. Home-owner makes monthly payments of principle and interest that is sent to loan-holder (family member). In theory, the loan eventually gets paid off over X years.

    In a bank-reverse mortgage, the bank has the option to “call-in” the loan balance if certain things happen, like major repairs. Also, if the homeowner defaults the home goes to the bank in forclosure.

    In a private-reverse mortgage, the loan-holder (family member) could likely also call in the loan based on the same triggers, but probably wouldn’t because it either you’re making your family member homeless and/or you won’t get your return of investment during forclosure.

    If your family member dies or stop making payments, you still can collect the home as collateral upon their death.

    • who? says:

      I was totally not understanding the “call-in” section. The way a reverse mortgage works is the old person owns a paid-off home, and the bank pays the homeowner sime amount of money every month, usually for 10 years. Then, when the homeowner dies, the home is sold, and the bank gets a lump sum back out of the proceeds of the sale.

      I think what it’s saying is that if the bank decides it isn’t going to get its money back in a sale, it can force the homeowner to pay back the lump sum immediately.

      • Loias supports harsher punishments against corporations says:

        Ah, that makes sense to me. I didn’t have it quite right.

      • williamv1982 says:

        Not exactly. A reverse mortgage can come in many varieties but the basic kinds are a credit line that can be drawn down at the homeowner’s discretion (like a HELOC), a lump sum payment, a fixed payment for a predetermined amount of time, or a fixed payment for life. Obviously the last option is the riskiest from the lender’s perspective so it’s going to be the most expensive.

        The homeowner never has to pay back the loan unless they move or die. They cannot call the loan just because the equity left in your home falls, that could happen because home prices go down or you just live too long and the accrued interest on your withdrawals is larger than the bank anticipated. That’s the whole idea behind the reverse mortgage, if you run out of equity the bank isn’t allowed to call your loan. There are terms that allow them to call the loan if the home isn’t being maintained properly but that is really intended to be used for severe neglect or non payment of property taxes etc. The vast majority of HECMs are government insured anyway so the bank isn’t exposed to credit losses from a simple lack of equity.

        Conceptually there isn’t anything wrong with a HECM, in fact they offer a good life expectancy hedge for the elderly. If you live longer than expected the HECM protects you from liability that a normal mortgage would expose you to. Practically HECMs are incredibly expensive, 2 points for the upfront mortgage insurance, ~2 points for a small home in origination fee, another 1.25 points running for ongoing mortgage insurance, plus whatever other fees the lender is going to throw in. That’s pretty pricey just to turn a regular mortgage into a non callable negam loan. If possible I think it almost always makes more sense to just use a regular mortgage product and manage the risks yourself.

  4. VeryFroid says:

    “The forwarded money, with interest, is tracked and recorded. When it comes time to sell the home, the investors are able to regain their contributions along with the interest it earned.”

    This article seems to assume that the intended heirs are also the ‘investors’ ? So the investors are getting paid ‘back’ with their own inheritance ?

    I would think that if adult children have the means to support their parents, they would do so and wouldnt want or need ‘collateral'; especially when the ‘collateral’ is something they ultimately will inherit anyway.

    I see lots of hazards when there are multiple heirs/investors; some able to contribute to the parents/seniors support more than others and then the more poor heirs find that they have nothing much to inherit.

  5. TheUncleBob says:

    Don’t lend money to family. Ever.

    Give it as a gift.

    If they give you a gift of equal value later, bonus. If they don’t, no harm, no foul.

    If you’re unwilling to take the loss of giving the money as a gift, then don’t give the money.

    The borrower is slave to the lender.

    • Loias supports harsher punishments against corporations says:

      This a pretty notable exception to that rule. You ony get your return when the person dies. So you helped them with what they needed until they died, and you are rewarded for it.

    • pythonspam says:

      Thanks, Dave Ramsey.

  6. herblock says:

    I was at a foreclosure sale a few weeks ago and a reverse mortgage company was foreclosing on a house. How could that be? They have the deed and are basically paying rent to the former owners who live there.

  7. gman863 says:

    Watching Fred Thompson and Robert Wagner pitch these things din’t surprise me.

    Yesterday, I saw Henry (“the Fonz”) Winkler doing an ad for one.

    Say it isn’t so!

  8. who? says:

    My mom in law had a reverse mortgage. It worked well for her. She had a home, but had outlived her savings, and she used it to pay her living expenses for the last 10 years of her life. When she died, the house was sold, the bank paid back, and the estate got what was leftover. Before she got the reverse mortgage, we had been supporting her for a couple of years. The reverse mortgage took pressure off of us, and gave her some autonomy to do what she wanted with her own money, without having to beg for money from us every month.

    As far as the downside, however, the loan period was 10 years, and if she hadn’t conveniently died during the last month of the loan, we would have been supporting her again.

    Frankly, the fact that we gave her money caused nothing but trouble. She had her will changed so that she paid us back out of the estate, but didn’t explain to the siblings *why* she was giving us more money than anyone else, because she didn’t want to admit that she’d run out of money. The problems this caused have never been resolved.

  9. PragmaticGuy says:

    Also, a reverse mortgage only gives about 60% LTV whereas a regular mortgage will give 80. Reason being, since the lender can’t throw you out of the house, should you live another 40 years they have to wait for that money.

  10. Robert Nagel says:

    Don’t buy anything that’s advertised on late night TV unless it’s less than $29.99. Real estate transactions especially with gold purchases right behind.

  11. 808 says:

    With mortgage interest rates at very low levels, I wonder whether a more viable, less fee-laden approach might not be to refinance the house with parent(s) and offspring being tenants in common, which enables the owners to set the relative percentages of ownership.

    If the home had been paid in full, i.e. no mortgage, give the parent(s) the loan proceeds immediately to invest and draw from for living expenses. With a relatively low mortgage, offspring might be paying P+I similar to what they’d be giving their parent(s) in cash. I suspect this approach would be cleaner for tax purposes, even if any of the parties held the asset in revocable living trust, and might also provide tax benefits.

    In addition, if not all offspring participate in this process, the fact that some of them are paying the mortgage would illustrate to the others what had been going on and would avoid the generation of hard feelings.

  12. Yuri says:

    Although reverse mortgages do have their place, and a HUD reverse mortgage can be a good option in some cases, they are expensive, and I agree completely with your advice that seniors should always look into all of the government assistance programs that could possibly help them, and discuss their options with their families, before they resort to any form of reverse mortgage.

    I would also recommend that they check out http://www.eldercaredirectory.org/ which is a clearinghouse of elder assistance programs and agencies nationwide. Also, they shouldn’t overlook the property tax rebate and exemption programs which many states have for seniors, veterans, and the disabled, which can help reduce their property tax burden by fifty percent or more in some cases.

  13. reybo says:

    An example of “policing themselves” is this ad last week in the Newport News, VA, Daily Press. The display ad on page 4 said,
    “I’m so glad Jim protected us with a Reverse Mortgage. Now I can stay in my home payment free.” (Catherine Kincaid, spokesperson)

    Get Tax Free Cash
    No More Mortgage Payments
    Property Passes to Your Heirs
    No Income or Credit Requirements

    Licensed by the Virginia State Corporation Commission MC2950
    =================
    Great line about the heirs!

  14. Big151red says:

    There needs to be a few things cleared up on this, first you can receive “money for life” it is called a tenure plan. It does pay out a lot less then if you select a term plan were you pick how many years you will get money. The idea of a private reverse mortgage is not very popular right now because they are not FHA insured. What that means is the bank will get the full amount owed to them, no matter what the home can be sold for, this means that people who got reverse mortgages in 06 and 07 and then had their homes lose a lot of value don’t have to worry about losing their homes, as long as they keep up on taxes and insurance. If you made a private loan, the inverter has now lost a large amount of money. Then as for as foreclosures are concerned, you can have a tax foreclosure no matter what type of mortgage you have, even if you don’t have a mortgage at all. The most common type of foreclosure you see with reverse mortgages is when the home owner(s) die and the kids who got the house can’t sell it for enough to pay back the loan, they do surrender the deed to the bank instead of foreclosure, the bank still has a REO property now and sells it as a foreclosed on home, the kids never have to pay a penny out of pocket and won’t have their credit hurt by this transaction. A reverser mortgage is a great tool for those who are in need of it, but that is not every senior out there. Only a small amount of senior home owners will really benefit from this program, if you want to learn more, talk to a company that does not send you an application when you first call in, talk some one that will take time to learn about your situation and is willing to talk to family members as well. Getting a good loan officer for these is very important.