Reverse mortgages – the good, bad and the ugly
Congratulations seniors, these are your Golden Years. Your Social Security check exceeds your expenses and your children are all doctors and lawyers who never ask for handouts and seem terribly happy with their lives. You have very few wrinkles and a head full of dark hair. Your home continues to appreciate annually and your mortgage is paid off. All of your other debts are paid, and you owe nothing to the world at large. That pension or retirement account you worked for is paying off in spades and its fiduciaries are always making the right decision at the right time so that you never have a loss. What is that? This isn’t your story? You’re not alone.
According to the Institute on Assets and Social Policy, the reality is that one-third of senior Americans lack money or is in debt after meeting essential expenses each month. A mere twenty years ago, most seniors entered retirement without debt. Today’s seniors face mounting debt levels fueled by increasing medical bills, mortgages, and credit card debt arising from marketing campaigns that promise the world will be brighter if only everyone had more stuff. Still other seniors fall prey to college and university promises of enriched lives and higher salaries if only they return to classes while assuming new student debt.
Unlike their parents, today’s seniors were the first generation raised on credit cards and they often carry debt into their retirement. The Survey of Consumer Finances reports the average credit card balance for 65 to 74 year olds was $2,100 in 1989; by 2010 it rose to $6,000. As a result of this mounting credit card debt, the total average debt accrued by seniors is rising as well. According to the Employee Benefit Research Institute, the total average senior debt ballooned to $50,000 in 2010, an increase of 83% from 2001.
For seniors who own a home, there is hope. Jamie Hopkins, a contributor to Forbes magazine, referencing the 2011 U.S. Census data, notes that for many retiring American couples, home equity represents 2/3 of their total net assets. To that end, many seniors must use home equity as part of their retirement savings strategy. While their home’s equity can be effectively utilized as part of a retirement income plan to improve financial security, because home ownership takes time and because a home represents a significant amount of some retirement portfolios, home equity decisions should be made very carefully. Seniors should first decide upon their intended lifestyle and make a budget to determine if and when their home’s equity must be used for retirement goals. If the decision to tap into home equity is required, there are a variety of ways to do so including: (1) Selling your home and downsizing; (2) Selling your home and moving in with family members; (3) Selling your home and leasing it back from the buyers; (4) Using a conventional home equity loan to lien your home with debt; (5) Utilizing any special purpose loans made available in your state; (6) Taking on tenants in a home sharing program; and (7) Securing a reverse mortgage.
For financial advisors, there is necessity in using their client’s home equity as part of any retirement savings plan. Because Americans are saving less, financial advisors have fewer assets to invest and use in the support of their clients.
What is a reverse mortgage? A reverse mortgage is a loan occurring when homeowners borrow against their home equity (the amount they have already paid toward the home loan). Unlike traditional home equity loans, with a reverse mortgage you do not pay back the money you borrow as long as you live in the home. The immediate benefit to homeowners who lack sufficient income is the ability to eliminate ongoing mortgage payments (most borrowers must still pay insurance, property taxes and maintenance costs). For those borrowers with sufficient home equity, they can also obtain access to cash to use in any manner they choose such as paying off credit card debts attached to alarmingly high interest rates or paying off incredibly high medical bills. The amount of a reverse mortgage is based upon appraised home values and the percentage of equity in each property. Like most loans, borrowers pay closing costs and some loans incur a monthly servicing fee. Reverse mortgage borrowers who decline lump sums can instead elect to receive their money in a monthly distribution or a line of credit.
But like anything, there are downsides to reverse mortgages. First, not everyone qualifies for a reverse mortgage. You are eligible for a reverse mortgage if: (a) you are 62 years of age or older; (b) you own your own home and use it as you primary residence; (c) your home is a single-family, multi-family (up to 4 units), or an approved condominium or manufactured home; and (d) your home is in good condition prior to the reverse mortgage process. Each borrower must meet with a HUD approved counselor before obtaining a reverse mortgage and all prospective borrowers must undergo a financial assessment to qualify. The counseling helps each borrower understand how the loan works and the different alternatives that are available. It also confirms all prospective borrowers can pay for property taxes, homeowner’s insurance, basic home maintenance, and homeowner association fees, if applicable. Those expenses are normally paid by the borrower even after the loan is completed.
Second, borrowers often accumulate interest and closing costs. While there are no monthly payments on a reverse mortgage, the amount home owners must pay back often grows larger over time. While the amount owed on the loan will never exceed the value of the home, the loan and accumulated interest become due when the borrower(s) die or move out of the home. Third, unexpectedly low loan amounts are sometimes the result of the process; some reverse mortgage borrowers are disappointed by the amount of money they are allowed to borrow. The actual loan amount is determined by a complex calculation using the appraised value of the home, the amount of money still owed, the age of the borrowers, and current interest rates; (3) Borrowers must pay back the money if they don’t live in the home. This includes a residential care facility. At a time when money is tight, this can be a real burden on most seniors; (4) Borrowers must still pay insurance and regular maintenance on the home; (5) Guilt associated with borrowing money at a time when seniors are expected to have no debt; and (6) Reducing the amount of an estate – thereby reducing the amount of assets left to loved ones. For those hoping to leave a legacy to their loved ones, this normally reduces an estate substantially.
Reasons to avoid reverse mortgages also include: (1) if others reside in the home and want to keep it as their residence when the borrower dies; (2) if you do not plan to reside in the home for a long time, you should avoid reverse mortgages as the expense over a short time period is high and they only get progressively less expensive if you remain in the home for longer periods of time; (3) if it is important that you leave your home to your family without debt attached to it, reverse mortgages are a bad decision; and (4) once a home is not used as the borrower’s primary residence for 12 months, many reverse mortgages become due.
Reverse mortgages are a saving grace for some seniors and a short-sided and unwise decision for others. The decision to use a reverse mortgage is best limited to those who own real property and reverse mortgages should be made only after careful consideration and with assistance of counsel and family members. For some, the benefits outweigh the costs of the loan; to wit, the guilt of another obligation, and the reduction in their total estate value. For others, the loan amount disappoints and the need to pay back the loan when they are required to enter a residential care facility may compound their problems at a time when they can hardly afford more issues.
Todd Miller is a longstanding contributor to Active Life and regularly writes and speaks on various legal topics including estate planning, probate, elder law, and property taxes. He formed the Law Office of Todd Miller, LLC, 1305 Southwest Blvd., Ste. A, Jefferson City, Missouri in 2006. He was recently recognized by the Missouri Bar for his contributions to lawyer education and has was recognized as 2016 Adviser of the Year by GolfInc; and Golf Tax Consultant of the Year by Boardroom Magazine three times. Mr. Miller earned his juris doctorate degree from the University of Missouri School of Law in 1999 and graduated with honors from Lincoln University in 1991. You may find him at www.toddmillerlaw.com (573) 634-2838 or on Facebook, LinkedIn, and Twitter.