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Reverse Mortgages — What Should You and Your Parents Know Before Applying?
The number of reverse mortgages backed by the government
jumped nearly 20 percent in March and April alone from the same
period in 2008. At a time when seniors have seen their
retirement assets depleted by market losses, tapping home equity
has been a safety net. But it can be a risky one.
If your parents are at least 62 years of age and have
significant equity in their home, a reverse mortgage can turn
that equity into tax-free cash without forcing them to move or
make a monthly payment.
If it's right for them, it's a worthwhile financial tool. If
not, they could make some serious mistakes with their financial
future.
A reverse mortgage gets its name because of the way it works.
Instead of the borrower making payments to the lender, the
lender releases equity to the borrower in a number of forms:
- A lump sum cash
payment;
- A monthly cash
payment;
- A line of credit
(which tends to be the most popular option);
- Some combination
of the above.
When the owner dies or moves away, the house can be sold, the
loan paid off and any leftover equity value can go to the living
owner or the designated heirs. Heirs don't have to sell the
house. They can either pay off the reverse mortgage with their
own funds or refinance the outstanding loan balance within six
months with the option of two 90-day extensions that must be
applied for.
There are three basic types of reverse mortgages:
- Single-purpose
reverse mortgages, which are offered by some state and
local government agencies and nonprofit organizations;
- Home Equity
Conversion Mortgages (HECMs) are federally insured
reverse mortgages backed by the U. S. Department of Housing
and Urban Development (HUD);
- Proprietary
reverse mortgages are private loans that are backed by
the companies that develop them.
The size of a reverse mortgage is determined by the
borrower's age, the interest rate and the home's value. The
older a borrower, the more they can borrow, but the amounts are
capped by the maximum FHA loan limit for each city and county.
Reverse mortgages have traditionally been chosen by older
Americans who can't cover everyday living expenses or who
otherwise need cash for such things as long-term care premiums,
home healthcare services, home improvements or to pay off their
current mortgage or credit card greater than their income can
support. More recently, though, they've become popular with
individuals who see them as a better alternative to home equity
lines. Some use the proceeds to supplement monthly income, buy a
car, fund travel and second homes and evaluate with the help of
a financial adviser if reverse mortgage funds can be used to
restructure estate taxes.
Elderly borrowers will have to consult with a financial
advisor before they're granted this loan - that's one of the
requirements. They should consider a Certified Financial Planner
™ professional to do this because reverse mortgages can be
complex and risky. This step can be completed within the first
few days of the process. The basic loan closing now takes place
in about 30-40 days from the date of application. Generally the
only out-of-pocket cost is an appraisal fee ranging from $300-
$500.
Here are other things to consider:
Cost can be substantial. Reverse mortgages are
generally more expensive than traditional mortgages in terms of
origination fees, closing costs and other charges. The basic
FHA-backed HECM loan finances these fees into the initial loan
balance, and they can run between $12,000-$18,000. The loans are
based on anticipated home value appreciation of 4 percent a
year, so if the housing market is healthy, those costs are
generally recovered in a short period of time. But if the
housing market sours, it will definitely take longer to recoup
those fees.
They'll need to make sure they're not endangering their
Federal retirement benefits. The basic FHA HECM is designed
as tax-free income to the senior receiving their Social Security
income. However, if their total liquid assets exceed allowable
limits under federal guidelines, they might endanger your
benefits. This is another critical reason to work with a
financial adviser on this decision.
Rates can be higher. Reverse mortgages have rates that
are typically higher than those charged on conventional
mortgages. Interest is charged on the outstanding balance and
added to the amount they owe each month. Again, check the total
annual loan cost.
Their mortgage can be called. The homeowner or estate
always retains title to the home, but if they fail to pay your
property taxes, adequately maintain their home, pay their
insurance premiums, or change their primary residence, the
lender can declare the mortgage due or reduce the amount of
monthly cash advances to pay those overdue amounts.
The family needs to talk. If your parents' house is
their major asset, getting involved in a reverse mortgage may
not leave much to the next generation — if it appreciates, there
may be some difference that the kids can have. That's why that
in addition to discussing a reverse mortgage with a financial
adviser, parents and their adult children need to talk with
their family.
August 2009 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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