May 1, 2016
I think it is fair to say we have all had clients who, for emotional reasons, want to stay in the marital home yet can’t afford the mortgage payment or cost of maintaining the house. Emotions are taking precedence over good financial decisions, and this client could be jeopardizing their future. In some situations there may be a way to solve this problem, satisfying the client’s wish to remain in the home and yet relieve him or her of some of the financial burden. This tool is the reverse mortgage.
In a reverse mortgage the homeowner takes out a loan from the bank, using the home as collateral. However the homeowner is not obligated to make a monthly payment. Instead interest accrues monthly and is added to the loan balance. At some point in the future, usually when the house is sold, the loan is paid off. One benefit of the reverse mortgage is that the homeowner never owes more than the value of the house, even if the loan and accrued interest is an amount greater than the market value. Let’s look at an example of how it works:
Scenario #1: Connie, age 64, was awarded the family home in the divorce (and a small IRA worth $50,000). She loves her home, valued at $500,000, and wants to stay in it but the house is large and needs repairs. She is very concerned about her cash flow and her ability to make payments on a mortgage. Her mortgage payment is $2,000 per month. After struggling with mortgage payments, property tax payments and upkeep she finally realized she needed to downsize to a smaller home. Tearfully she sold the family home, netting $150,000 in proceeds. She purchased a townhouse for $245,000 with a $70,000 down payment. With a mortgage of $175,000 her monthly payments were $1,200 per month, saving her $800 per month over her previous mortgage. But the remaining $175,000 cash was used up over the next 12 years to make those mortgage payments.
Scenario #2: Let’s take the same facts – Connie, age 64, was awarded the family home with the mortgage payment of $2,000 per month. She is also very concerned about her cash flow and her ability to make payments on the mortgage. She did an immediate reverse mortgage and was able to borrow enough to pay off the mortgage and also had additional funds available to tap into at any time in the future. She was able to stay in her home, and had no monthly mortgage payment after that. So she saved $2,000 per month, and was able to keep up with the property taxes and maintenance.
There are some stipulations for reverse mortgages:
- The owner (and spouse) must be at least 62 years of age.
- It must be their primary residence – at the point the owner moves out for more than 12
months the loan must be repaid.
- The interest on the loan is added to the mortgage each month.
The benefits of the reverse mortgages are:
- There are no credit or income requirements to qualify for the loan.
- The buyer still owns the house.
- The house may be sold whenever they wish.
- If, when the house is sold, the mortgage is higher than the value of the house, the owner
has no liability to make up the difference.
This is a simple description of a reverse mortgage and how it works. There are, of course, more details that should be reviewed carefully before deciding to utilize this tool – it’s not right for everyone. But it’s useful to know that there may be a way for your client to stay in the house without becoming impoverished in the process.