Effects Of Reverse Mortgage Can Negatively Impact Estate Heirs

Reverse mortgages have been in the news lately, largely due to the changes in the laws that make the process of attaining one more difficult.[1]

While we have all seen the commercials where actor Robert Wagner extolls on the virtues and benefits of reverse mortgages to eliminate those pesky monthly payments or provide older Americans with a cash-flow to live on, it often seems too good to be true.

So, the question is, what are they not telling you, what hidden pitfalls can arise from a reverse mortgage, and what effect can a reverse mortgage have on your estate and your heirs.

Reverse Mortgage 101: What Is It And Who Qualifies For It?

First, it is important to know what exactly a reverse mortgage is, what it does, and what qualifications are needed to attain one, in order to decide if it is the right solution for you.

Put simply, a reverse mortgage is a special type of loan that allows homeowners to access a portion of their home equity (value) in their homes as cash; instead of making payments to the lender, they can receive money from the lender. The money received, and the interest charged on the loan, increase the balance of the loan each month.[2} The loan allows homeowners to access a portion of their home equity as cash, and would need to be repaid when the borrower sells the home, moves out of the home, or dies.

To qualify for a reverse mortgage:

  • You must be at least 62 years old.
  • Your home must be your primary residence.
  • You must have paid off some, or all, of your traditional mortgage.

If you still owe money on your original mortgage, you must use part of the money from your reverse mortgage to pay off the traditional mortgage. There are limits to how much money you can borrow; if you still owe a lot of money on your traditional mortgage, you might not qualify for a reverse mortgage.

Important: With a reverse mortgage, you must continue to pay your property taxes and homeowners insurance; your loan can become due immediately if you don’t.

Download the Consumer Financial Protection Bureau Brochure: Considering a Reverse Mortgage? (PDF opens in new window)

According to Lori Trawinski, senior strategic policy advisor with the AARP Public Policy Institute, “Reverse mortgages are a useful tool for some people. They can enable retirees to age in place, but we always emphasize that these are loans, and as such, borrowers have obligations.”[3}

Most reverse mortgages today are insured by the Federal Housing Administration (FHA) through its Home Equity Conversion Mortgage (HECM) program. This program requires that you meet with a reverse mortgage counselor to discuss how a reverse mortgage works and how much it will cost you. The counselor must be approved by the Department of Housing and Urban Development (HUD). FHA also requires that your home be in good shape. If your home is poorly maintained, you may need to repair it before you can get a HECM reverse mortgage.

Learn more: Top Ten Things to Know if You’re Interested in a Reverse Mortgage – Frequently Asked Questions about HUD’s Reverse Mortgages

For more information and details, read Reverse Mortgages, the Consumer Financial Protection Bureau’s Report to Congress.
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The Downside Of Reverse Mortgages

The potential pitfalls of a reverse mortgage must be carefully considered. Let’s take a look at two scenarios that illustrate the pros and cons of a reverse mortgage.

First, let’s look at Bob, a 75 year old single man with no children, living on a fixed income. His pension and Social Security barely cover his monthly expenses, and he is concerned that he may be unable to cover his mortgage payments or pay all his bills as the cost of food, utilities, medical care, etc. continuously increases. In this scenario, a reverse mortgage may be the right option for Bob; it can protect his home from foreclosure and provide funds to help make his life a little easier. Since the money he would receive is considered a loan, not income, he wouldn’t have to pay taxes on those funds. The loan, and any applicable taxes, would become due only if he moved out of the home or when he passed away.

Now, let’s change the scenario. Bob and Mary have been married for 55 years, and have 3 grown children. When they bought their house in 1960, it was still common for a home to be purchased in the husband’s name only. In this case, if Bob had taken a reverse mortgage, it would be very possible that the loan would become due at the time of his death. If Mary were unable to repay the loan, she could be forced to sell the home and move out. The time, money, and love Bob and Mary invested in their home could go up in smoke, leaving them with no legacy for their children.

The next thing you need to consider is that the fees involved with obtaining a reverse mortgage can be considerable, which can include:

  • Origination Fee, formerly called a Home Equity Conversion Mortgage, or HECM – 2% of the initial $200,000 of the home’s value and 1% of the remaining value, up to $6,000
  • Mortgage Insurance – fee based on the amount of funds withdrawn during the first year; 0.50% of the home’s appraised value if no more than 60% of the amount available is taken in the first year, and 2.5% if more than 60% is taken.
  • Appraisal fees, which vary by region but average around $450.
  • Any needed repairs to the home, as noted by the appraiser’s report, must be completed as a condition of approval.
  • Closing costs – comparable to those of any mortgage loan; usually amounts to about $1,000.

As you can see, you shouldn’t rush into this decision, as it can rapidly become a costly proposition.

Heirs Can Face Hurtles From Lenders When Trying To Settle The Estate

One of the most important stipulations of the laws governing reverse mortgages, and one that lenders may tend to overlook mentioning, is that when the loan comes due, surviving family members are supposed to be offered the option to settle the reverse mortgage for a percentage of the amount due, generally 95% of the difference between the selling price and the loan balance. Any shortfall, if the home sells for less than the debt, would be covered by the federal insurance fund that all borrowers are required to pay into each month.[4] This provisions provides heirs with an opportunity to retain the property at a reasonably affordable cost.

However, some lenders attempt to foreclose just weeks after the borrower dies. Heirs have reported that they were plunged into a bureaucratic maze as they attempted to get details about how to keep their family homes from the lenders.
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Reverse Mortgages: The Bottom Line

If you are considering a reverse mortgage, PROCEED WITH CAUTION!

  • Don’t sign the loan documents unless you understand how a reverse mortgage works.
  • Know your options — you may have a better choice.
  • Discuss this important financial decision with friends, family, or someone you trust.
  • Have a serious talk with a housing counselor before you make any decisions, which is a requirement to obtain a federally insured reverse mortgage.


Download the Consumer Financial Protection Bureau Brochure: Considering a Reverse Mortgage? (PDF opens in new window)
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References:
1. 15 U.S. Code § 1648 – Reverse mortgages; Legal Information Institute, Cornell University Law School
2. What is a reverse mortgage?; Consumer Financial Protection Bureau (CFPB); updated 4/3/2014
3. Are reverse mortgages easy money or just a dumb move?, by Shelly K. Schwartz; CNBC.com, March 23, 2014
4. Pitfalls of Reverse Mortgages May Pass to Borrower’s Heirs, by Jessica Silver-Greenberg; New York Times, March 26, 2014
How Reverse Mortgages Work in 2014, by Jim T. Miller; Huffington Post, April 14, 2014
Reverse Mortgage Realities, by Lisa Prevost, NY Times, April 10, 2014
Reverse Mortgages Report to Congress, Consumer Financial Protection Bureau; June, 2012
Home Equity Conversion Mortgages for Lenders (HECMs); U.S. Department of Housing and Urban Development
Frequently Asked Questions about HUD’s Reverse Mortgages; U.S. Department of Housing and Urban Development

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