Reverse Mortgages and the Probate Estate Dilemma
September 19, 2012
We have all seen them, the commercials late at night, a stately gentleman, graying hair perfectly parted speaking of the virtues of a reverse mortgages and how they can benefit older Americans entering retirement. Once the pitch is completed the closing image is that of the typical American family surrounding grandma or grandpa on the porch enjoying what appears to be a beautiful day thanks the reverse mortgage. The reality however is often very different.
What is a reverse mortgage? A reverse mortgage is a home equity loan that unlike a conventional loan disburses the monies borrowed to the borrower in monthly installments over a period of time. The reverse mortgage is secured by a deed of trust on the property for an amount which usually includes not only the money borrowed but also an additional amount sufficient to cover the interest payments on the loan until the borrower passes away. The reverse mortgage becomes due and payable to the lender when the borrower passes. Thus the borrower or their estate at the time of the borrower’s death may end up owing the reverse mortgage company a significantly larger amount of money than the borrower initially borrowed or received. If the property is the principle residence of a least one surviving borrower the loan will not become due and payable until that surviving borrower passes as well.
Once the borrower passes their estate is typically given four options: One, the estate can elect to pay off the reverse mortgage with proceeds from the estate; Two, the estate can refinance out the reverse mortgage with a conventional loan, which in effect is paying off the reverse mortgage; Three, the estate can elect to sell the property, whereby the reverse mortgage will be satisfied from the proceeds of the sale and the balance of the equity will be paid to the estate; Four the estate can issue a deed in lieu of foreclosure to the lender to avoid the lender from initiating foreclosure proceeding against the property. Typically, the lender will make a request of the estate shortly after the borrower has passed and will give the estate 30 days to elect which of these options it wishes to pursue or face foreclosure. A far cry from the beautiful day the commercial depicts.
There are benefits to a reverse mortgage. The borrower has the tax free use of their home equity as long as they continue to live in their home. However, that’s right if you have to go to a nursing home or assisted care facility and cannot return to your home because you require constant care, that may trigger repayment of the reverse mortgage. While the money is tax free, as the old saying goes nothing in this life is really free. The reason the money is tax free is because it is your equity in your home, which you already paid taxes on when you earned it and paid your mortgage to accumulate equity in the Property.
While withdrawing the equity from your residence while you are alive through a reverse mortgage can be a way an effective means of passing a portion of your estate to your loved ones while you are alive without tax penalties, the costs to your estate in the form of interest on the reverse mortgage loan and related fees and obstacles the reverse mortgage process involves, often exceed the benefit for most Americans.
It’s important to remember that in order to qualify for a reverse mortgage the lender will often require that your property be free and clear of any other lien in order for your property to qualify as security for a reverse mortgage. In some instances the lender may wrap the balance of your existing mortgage into the balance of your reverse mortgage. However, as they say, “the devil is in the details”. A reverse mortgage is typically not for the full value of your home. The amount of loan that you will qualify for is based on the lowest selling margins for your areas.
For example, if your home is worth $431,000 in today’s market, the value limit the lender places on the property may reduce your home’s value for the purpose of computing the reverse mortgage to $362,790 which would result in loan principal limit of approximately $259,395. This would be the absolute maximum the reverse mortgage lender would lend on a house worth $431,000. Remember the reverse mortgage lender is going to subtract all of the lender’s fees upfront, let’s say approximate, $17,125 to give you $236,621 as your net principal limit. However, when the reverse mortgage company records their deed of trust on your property, they are going to record it for the $362,790 amount. Thus, your property is significantly more encumbered than the amount of money the borrower received. These assumptions are based on the borrower taking monthly payments; the situation is even direr if the borrower elects to take a lump sum payment.
So while the reverse mortgage commercial may seem enticing, a way to provide for your golden years, beware, that the sunny day the commercial promises may cause more agony and trouble for your heirs then you ever intended.