Recently, there has been a large spike in the number of reverse mortgages advertised, claiming that they were an easy way for seniors to make money during retirement. However, reverse mortgages turned out to be a financial disaster for many senior homeowners and their families. Tens of thousands of retirees lost their homes to foreclosure after defaulting on what was promised to be a “risk-free” way to convert the equity in their homes into cash.
They were aggressively marketed mainly to low-income homeowners, who possessed minimal financial assets outside of the equity in their homes and thus the very people most likely to default. Although the federal government has recently enacted new laws to better protect seniors, reverse mortgages are still being hyped as a safe way for retirees to obtain much-needed cash.
Last week, we talked about how reverse mortgages work and discussed the devastating effects they can have on senior homeowners and their spouses when things go wrong. Here, we’ll cover the potential risks reverse mortgages pose for your family and estate plan.
A reverse in value
When it comes to reverse mortgages, you must not only consider the negative effects such loans might have on you while you are living, but also how they could affect your estate and family when you die. Like any loan, a reverse mortgage is a debt that decreases the value of your estate, but unlike most loans, the balance of a reverse mortgage increases with time, rather than decreases.
With a traditional mortgage, you accrue equity and lower the balance of the loan with each payment you make. Upon your death, your estate receives the net equity from your home, minus the balance, if any, remaining on your mortgage. So in most cases, the longer you hold a traditional mortgage and the more payments you make, the more value your home will add to your estate.
But with a reverse mortgage, it’s the exact opposite. With a reverse mortgage, you’re taking out a loan against the equity you already have in your home. Since you’re receiving payments from the lender, rather than making them, the equity you have in your home decreases over time, while your loan balance increases. Thus, the longer you hold a reverse mortgage, the less value your home is likely to add to your estate.
The effect on your family
If you take out a reverse mortgage, you can still leave your home to your family in your estate plan. However, you’ll not only leave your loved ones a less valuable asset, but they’ll also have to pay off the balance of the loan after you die unless they want a foreclosure.
Whomever you select to inherit your home will typically get six months to pay off the reverse mortgage. They should move as quickly as possible because until the loan is settled, interest on the balance and monthly insurance premiums will continue to eat into any remaining equity. That’s why unless your family has enough money on hand to fully pay off the reverse mortgage upon your death, they’ll probably end up having to sell the home. If so, the proceeds from the sale can be used to pay off the loan, including all fees and interest, and your family keeps any remaining equity. Keep in mind that this is the best-case scenario.
More trouble than they’re worth
While reverse mortgages are designed to stay within the equity value of your home, this only works as long as home values are rising. If home values crash, like they did during the recession, the balance of your reverse mortgage could end up exceeding the market value of your home. Fortunately, reverse mortgages are “non-recourse” loans insured through the Federal Housing Administration (FHA). This means your family won’t ever owe more than the home’s appraised value and lenders can’t come after your family or estate to recoup their loss.
If your reverse mortgage balance exceeds your home’s value at the time of your death, your family is only responsible for paying the lender 95% of the home’s appraised value. If your home’s sale doesn’t meet the lender’s expenses, an FHA fund insuring the loan pays the difference. Not surprisingly, this fund is currently more than $13.6 billion in the red, which reflects just how risky reverse mortgages can be.
As you can see, your family would have to go through all of the hassle of selling the home and end up with nothing to show for it. In such a case, your home would be more of a burden than a benefit to whomever ends up inheriting it, which is the exact opposite of how your estate plan is supposed to work. Given this, unless there’s equity in the home, your family would have little incentive to sell the property and may want to simply hand it over to the lender to avoid the time and expense of foreclosure. Known as “deed in lieu of foreclosure,” your loved ones can do this by signing the home’s deed over to the lender.
Mitigating the damage
Obviously, the best course of action is to never take out a reverse mortgage in the first place but if you already have a reverse mortgage on your home, it’s absolutely critical that your family knows about it. This is something that you must not hide from your loved ones. If you have a reverse mortgage, talk to your family now to discuss the available options. Telling your family that you’ve taken out a reverse mortgage may be embarrassing, but if your family is unaware of the loan and you die or need to move into a nursing home, they’re in for an awful surprise
A trusted advisor
Before you make any major life decision, especially one involving the family home, you should meet with us to discuss the potential impact on your loved ones’ future. You never know when one seemingly minor choice might end up causing all kinds of trouble for your family down the road. Contact your Personal Family Lawyer® today to learn more.
This article is a service of Levi Alexander, Personal Family Lawyer®. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Family Wealth Planning Session, ™ during which you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by calling our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.