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Estate Planning Law: Reverse Mortgages

A reverse mortgage or Home Equity Conversion Mortgage (HECM) is not new, but it is something that you may have heard much more about recently.  It is a mechanism that enables senior homeowners to convert a portion of the equity that they have in their home without having to sell or give up title or, most importantly, assume a new monthly mortgage payment.  They have been around for a long time but due to recent statutory changes have become less onerous and, when combined with current interest rates, more beneficial than in prior years.

The first reverse mortgage was done almost 50 years ago and, originally, was thought to be only useful to destitute widows.  In 1988, however, President Reagan signed a reverse mortgage insurance legislation bill and the government insured its first mortgage in 1989.  Since that time, their usage has grown and in fiscal year 2008, 112,000 were put into place with government insurance.

To be eligible to obtain a reverse mortgage, the youngest named homeowner and occupant of the property, as his or her primary residence, must be at least 62 years of age.  The home does not have to be owned free and clear in order to make application.  However, when a reverse mortgage is put in place, all other liens will be satisfied from a portion of the proceeds of the reverse mortgage.  To be eligible, the property can have up to 4 dwelling units so long as one of those units is occupied by the senior owner or owners.  Unlike standard mortgages, to be eligible for a reverse mortgage, an owner need not meet any income, asset, employment or credit checks.  The amount of the mortgage is derived utilizing the formula that takes into account the age of the youngest homeowner, the value of the property and the current interest rate. 

The older the owner and the lower the interest rate, the larger the portion which can be borrowed.

The proceeds of the mortgage can be taken in any number of combinations including lump sum cash advances, monthly payments for a fixed term or for life and/or a line of credit.

As noted, the homeowner retains title to the property and can use cash advances for any purpose.  There are no tax implications as a result of the income stream which may be generated and, thus, neither social security nor Medicare benefits will be affected.  Most importantly, should the owner die, move or sell the property resulting in the property being sold for an amount which is less than the accumulated principal and interest existing on the reverse mortgage, neither the homeowner nor his or her heirs or estate will ever be responsible to pay any shortfall.

The property being mortgaged need not be a stand alone property and can be a condominium or part of a planned urban development.  The owner, however, is required to undergo mandatory counseling by a HUD approved housing counselor.     There are further options available to the borrower.  For instance, while the reverse mortgage may originally be set up as a line of credit, there is nothing which keeps him or her, at a later time, from opting to take a lump sum or regular monthly payments either for a fixed period or for lifetime.

There is no standard right or wrong answer as to what type of payment to arrange.  This is dependent upon an individual’s age and needs.  The formula basically assumes that someone will live to be age 100.  That age is used as a protection for the FHA as the insurer since most people will not outlive the age factor in the mortgage. 

However, it is not unheard of for people to live beyond the 100 and if a “tenure” option is chosen for payments, payments can continue even though the amount being paid exceeds the value of the property.  While a payment for a fixed term will result in a higher monthly payment, it must be kept in mind that should the recipient live, payments can run out.

A line of credit can grow annually since the older a person gets, the higher the percentage that can be borrowed.  This figure is subject to recalculation at the time a request for monies is made.  These payments can, however, exhaust equity so that no further payments can be obtained.

If all of the equity is taken in a lump sum payment, there is no credit line excess or ability then to take lifetime or fixed period payments.

Just as there are choices to be made as to what type of payment to request, there is also an interest choice to be made.  One choice is to use a monthly adjustable rate which uses a measuring rate such as the one month T-bill or London Interbank Offer Rate (LIBOR) plus a fixed margin, or one can choose a fixed rate which varies with market at the time the loan is made.

The costs of a reverse mortgage are now controlled by statute.  Before a loan is closed, the borrower must be provided with an itemized estimate of the closing costs which include appraisal fees, title insurance, FHA mortgage insurance of 2% of the loan, recording fees, other closing costs and a placement fee of 2% of the loan but not to exceed $6,000.

The home which is placed as collateral must meet FHA guidelines although a termite inspection is not required unless the appraiser notes that one should be had, and most home repairs can be funded through the loan.  The borrower is obligated to keep property taxes current, maintain homeowners’ insurance, maintain the property in good condition and, of course, remain a resident within the home.  Permanent withdrawal from the residence will trigger a sale or pay off requirement.

Whenever the property is sold, whether voluntarily or as a result of a move or the death of the borrower, the loan must be paid including interest which has accumulated.  As noted, however, if equity is inadequate to pay the loan in full, the FHA insurance will cover the cost of any shortfall and no monies will be requested from the owner or his or her family or estate.  There is no penalty for early payment and, should it be desirable or advisable, the property can be refinanced.

Should one determine that a reverse mortgage is advisable for himself or herself, he or she will have an initial consultation with an FHA approved agent, fill out an application, go through mandatory counseling, have the property appraised, confirm that title is clear and submit the loan for underwriting.  This is followed by settlement and the deal is done.  The applicant will have to provide proof of identity and date of birth, his or her social security number, the fact that homeowners insurance is in place and a certificate of having successfully completed counseling as well as any applicable existing mortgage statement.

Prior to January of 2009, federally insured reverse mortgage could not be used to purchase a new home.  That is no longer the case and, thus, the reverse mortgage may be an ideal vehicle when considering downsizing.  Consider the aging couple who want to leave their McMansion and move to a low maintenance condominium.  The difference in costs of one versus the other could be several hundred thousand dollars.  Using only so much of their sale proceeds as is necessary when combined with a reverse mortgage in order to acquire the replacement home and not having a future monthly mortgage payment to make will free up the cash differential as a basis for an income stream for the couple.

While there is a cost involved in acquiring the reverse mortgage, for someone who opts to say in a home rather than sell it, the cost can be less than commissions which would have been paid on a sale.  Nevertheless, that person can remain in the home without a monthly payment and have either a monthly income, a credit line or a lump sum payment at the same time.

Whether this scenario is right or wrong for an individual must be determined on a case by case basis, and it may be desirable to do so in consultation with responsible family members.  For a further in depth discussion as to whether or not a reverse mortgage may make sense for you or a family member, please feel free to call your attorney at Wright, Constable & Skeen, LLP for an in depth question and answer session. 

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