If your parents are retired or nearing retirement and concerned about their finances, they might float the idea of getting a reverse mortgage past you.
After all, in that commercial, that nice man from Law & Order says that it’s a great way to get supplemental income in retirement.
Unfortunately, there is a great deal that the commercial leaves out.
And these issues are something that the reverse mortgage holder’s family—that is, you—will likely have to deal with.
After all, your parents aren’t getting any younger.
Here is the breakdown of what those in the Sandwich Generation need to know about reverse mortgage disadvantages—before Mom and Dad sign on the dotted line:
How Reverse Mortgages Work
At its core, a reverse mortgage is a way to convert the equity in a home into cash. In order to qualify for a reverse mortgage, the homeowner must be at least 62 years old, must own and live in the home, and must have substantial equity in the home. While lenders do not require that the home be completely paid off, the homeowner must be close to the end of their mortgage term in order for the lender to agree to a reverse mortgage.
With this loan, the lender will pay off whatever remains on the mortgage (if anything), and give the homeowner a payout in one of five ways: Tenure payments are monthly payments that will last for as long as at least one borrower still lives in the home. Term payments are monthly payments for a fixed period. A line of credit will allow the borrower to draw unscheduled payments for any amount whenever needed until the credit limit is maxed out. Finally, modified tenure and modified term payments combine the monthly payment option with the line of credit option.
Unlike a traditional loan, the borrower does not need to make regular payments in installments. Instead, the entire loan plus interest will come due when the borrower passes away, sells the house, or can no longer consider the home a primary residence.
For instance, if an elderly homeowner finds himself needing regular care, permanently moving to a nursing home will mean he has to pay back his reverse mortgage. However, the borrower has 12 months of living elsewhere before the home is no longer considered his primary residence. So a short time in a hospital or nursing home will not mean that the reverse mortgage is due.
One of the big benefits to a reverse mortgage is that the payments you receive from them are not considered taxable income. In addition, the payments will also generally not affect your Social Security or Medicare benefits. On those grounds, a reverse mortgage can seem like a good way for retirees to supplement their retirement income with their home equity without having to downsize or move.
The Fine Print
So far, so good. However, there are several aspects to reverse mortgages that can make them seem like less of a good deal.
First and foremost is the fact that you owe more money through a reverse mortgage as times goes on.
At the end of the loan term, either the borrower or his heirs will have to pay back the amount of the loan—which grows with each payment made to the borrower—plus interest.
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As for that interest, while there are some fixed-rate reverse mortgages, the majority of these loans use variable rates. (It is important to note that the usual way of paying off the loan is by selling the house, meaning reverse mortgage holders and their heirs do not actually have to cough up the amount of the loan when it is due, unless they want to keep the house.)
In addition, the entire point of the reverse mortgage is to cash out the equity. That means that the old homestead will have no equity (or very little) left at the end of the loan term. So sale of the house will leave no cash for the heirs.
If the borrower’s heirs are interested in keeping the home, they will have to pay off the loan in order to do so. Most reverse mortgages offer something called a non-recourse clause, which means the borrower cannot owe the lender more than the value of the home when the loan is due and the home is sold. Basically, whatever the home sells for will satisfy the loan. However, heirs who want to keep the home will still have to pay back the loan in full, even if the amount owed is more than the home is worth.
It’s important to remember that reverse mortgages are not free. Just like any mortgage, there are closing costs, including loan origination fees and mortgage insurance premiums. Some lenders also charge servicing fees during the life of the reverse mortgage.
Also, the amount that can be borrowed is dependent on several factors, including the youngest borrower’s age, the interest rate, and the appraised value of the house. So even homes that are worth quite a lot may not provide the kind of reverse mortgage amounts that borrowers are counting on.
Finally—and this can be a real kicker for the adult children of reverse mortgage holders—the homeowner still maintains the title for the house, which means he is still on the hook for maintenance, property taxes, and homeowner’s insurance. In fact, failing to maintain the condition of the house or pay taxes or insurance on it can mean that the loan becomes due. If your parents are having trouble keeping up with their household chores—including home maintenance and bill paying—these sorts of jobs will fall on you.
What Are Reverse Mortgage Disadvantages?
The answer to that depends upon several factors. First of all, your family needs to decide how important it is to keep the house in the family. If your parents are talking about taking a reverse mortgage on the house where you and your siblings were born and where you’ve dreamed of seeing your own grandchildren play in the future, then a reverse mortgage might not be a great idea. Unless you know you will be able to pay back the loan, you should plan on having to sell the house once your parents have entered into a reverse mortgage.
If the home is meaningful to your family, an alternative to a reverse mortgage is for someone in the family to buy the home from your parents and allow them to continue living in it. This will provide them with the equity in their home in a lump sum, and if that equity is $500,000 or less, they can exclude the money from their taxable income. In many ways, this is a win-win, although it does depend on someone in the family having the ability to purchase the house.
Even if you have no particular attachment to your parents’ home, you may want to think carefully about whether or not to pursue a reverse mortgage. Depending on their ability to live independently and keep up with the important tasks of home ownership, a reverse mortgage may or may not be a good idea.
If you have reason to believe that Mom and Dad only have a few years before they will need some serious help, it might make more sense to access the equity in the home by selling it and getting them moved to retirement home or assisted living facility where they will be more comfortable.
If, on the other hand, you know your Dad still fixes the roof, strings the Christmas lights, and mows the lawn, while your Mom still cleans the house from top to bottom and weeds the flowerbed every day and nothing is going to stop them, thank you very much, then a reverse mortgage might work for them. They will get to stay in their home while still enjoying the equity they worked to build up.
Are Reverse Mortgages a Good Idea?
The real issue with reverse mortgages is why your folks might need one. If they did not save adequately for retirement because they were irresponsible with their money, or if they have trouble living on a budget or a fixed income, the problem may be one that a reverse mortgage cannot solve.
If your parents keep you in the loop on their financial issues, take the time to sit down with them and their financial advisor to determine the best course of action to keep them happily puttering and wondering why you never call through many years of retirement. A hard look at numbers will help you all determine if a reverse mortgage disadvantages outweigh the potential benefits.