Posted On: May 22nd 2010
These days looking for cash in your home is difficult to do with a home equity line of credit. In certain circumstances, a Reverse Mortgage may be the best answer for someone who is equity rich and cash poor. Common uses for the loan proceeds are to pay living expenses in retirement, or to fund a business opportunity.
For example, a borrower could take a Reverse Mortgage and use money to pay property taxes. If the borrower takes a lump sum payment option, and in 10-15 years the money runs out the borrower could then refinance on the theory that the house is worth more, and they could be older and would be eligible to borrow more. The amount to receive in a second Reverse Mortgage depends on the facts and circumstances at time of refinance. However, beware; at refinance you must pay 4-5% again for closing costs. Further, the value of the house may have declined, and the borrower therefore may not be eligible to have a second Reverse Mortgage.
With a Reverse Mortgage, there is no pre-payment penalty; the reverse mortgage can be repaid at any time. This must be a loan against your primary residence, and the borrower remains on the deed as full title owner. A Reverse Mortgage can be done with a life estate: where a life estate is owned by the borrower/parent, and the children are on title as remainder. The children must sign on loan documents. As this is a non-recourse loan, the credit of the children will not be impaired because they are not personally liable.
There are several payment options for the borrower: a tenure plan, where there are monthly payments for life; a term plan, where there are monthly payments for a specified period of time; a line of credit, where advances are available in any amount, at any time; or a lump sum payment, where all funds are received at disbursement. The first three options offer a more cautious, slower rate of payment to the borrower, and may be a better choice for the borrower in order to be more eligible for Medicaid purposes. A lump sum would more likely disqualify them for Medicaid eligibility, and could be more dangerous to some borrowers to have such a large amount up front. The interest rate on a Reverse Mortgage can be adjustable or fixed.
As part of the Reverse Mortgage application process, the Borrower must receive counseling from an independent third party, obtain a certificate from that session and give same to the lender before the loan can be closed. The lender must give the borrower at least ten (10) names of independent counselors from which to select the required counselor.
There is no residency requirement for reverse mortgages. A borrower can do a reverse mortgage on a purchase. For example, a borrower may sell a property, take a forward (conventional) mortgage for part of cost of the purchase of the smaller new home, and reverse mortgage for the balance.
Before a Reverse Mortgage can be closed, all mortgages and any other lien on the property must be paid. The closing costs, which run 4-5% of the appraised value of the property, are paid by the borrower up front. The appraisal of the property is done at the outset of the loan, and there is no re-inspection of the property during the loan term. The current maximum appraised value of the property could be $625,500. To illustrate, if the house is worth $1,000,000, then the closing costs would be based on a value of $625,500. Further, if the house is worth $500,000, then the closing costs would be based on a value of $500,000. Previously, the maximum amount of loan obtained in a Reverse Mortgage (hereinafter “claim amount”) was $417,000. Recent stimulus legislation increased the maximum claim amount to $625,500. There is talk this will return to $417,000 shortly.
Therefore if you have a house valued between $417,000 and $625,500, this may be a window of opportunity. The title insurance and costs are also based on the maximum claim amount. However, beware; a loan is only based on a sliding scale of the borrower’s age. If the maximum amount to lend is $625,500, the borrower will only get that amount if she is 100 years old. The borrower, or youngest spouse if borrowing jointly, must be at least 62 years of age. One ordinary closing cost does not apply: this type of loan is not subject to New York State mortgage recording tax.
One reason the closing costs are high is that they include a type of PMI that in the event the value of the house is less than the amount of the mortgage at the time of loan repayment (i.e. death of the borrower), and there is no amount due by the heirs of the borrower. It is a non recourse mortgage.
It is a requirement of the reverse mortgage that property taxes and insurance remain current on the property. Unpaid property taxes and insurance are considered a default. It makes the calculations simpler to have the borrower pay their own real estate taxes and homeowners insurance from funds other than the Reverse Mortgage proceeds.
There is no income tax deduction for the accrued mortgage interest during the reverse mortgage term because cash basis rules apply– no mortgage interest was actually paid. However, by taking out the reverse mortgage, the borrower is reducing their estate taxes by having more debt.
The amount of time you anticipate spending in your home is another factor to consider when you are thinking about a Reverse Mortgage. A reverse mortgage is not recommended if the borrower is leaving their home in 1-2 years, because of the closing cost hurdle. It pays off after 3-5 years.
This is a brief overview of the Reverse Mortgage. It is not for everyone. However, it could be a good fit for certain situations. It is best to consult a financial professional and an attorney to discuss your particular facts and circumstances to see if it is a good fit for you.