Reverse Mortgage as an Estate Planning Tool

Everyone has seen the commercials on television advertising reverse mortgages.  Everyone has heard horror stories of elderly people “losing” their homes.  But what is the truth about reverse mortgages?  Reverse mortgages are not easy to understand, so I sat down with a reverse mortgage professional, Jeffrey Floyd of American Advisors Group,[1] to learn more myself. 
 
At the most basic level, a reverse mortgage is taking a loan out against the equity in your home. You can receive the loan proceeds in a few different ways: a monthly direct deposit, a lump sum, or a line of credit.  For example, if your house is worth $300,000, and you have no mortgage, you could qualify for a $150,000 reverse mortgage.  If you had a $150,000 traditional mortgage, the bank may still offer you that, but the $150,000 would go to pay off the traditional mortgage.  You would then have the benefit of not making a mortgage payment every month.
 
Any unused line of credit balance grows. You are charged interest against what you use.  However, you never have to make any payments to the bank. You must be 62 years old to get a reverse mortgage, and you must reside in the home. You must continue to pay real estate taxes, insurance, and home owner association dues.  If you have poor credit, the bank may set aside part of your reverse mortgage proceeds to ensure those bills are being paid.
 
The bank will “call” the loan (meaning, collect the debt) when the borrower dies or moves out of the home (which most often happens when the older person has to move in with a relative or nursing home).
 
I’ve made a list of pros and cons (in my opinion):
 
Pro:  You can use the money for practically anything. What was the most attractive about the reverse mortgage for me, as an estate planner, is that you can use the money to purchase life insurance or long term care insurance.  How many older people don’t have this insurance because it is too expensive for them because they waited too long to purchase it?  This way, if the older person does have to go to a nursing home, they have long term care insurance to pay for it.
 
Also, as an attorney who assists family members settling estates, I can tell you that most adult children do not care about inheriting their parents’ house.  Adult children typically have their own homes, and they may not even live in the area.  Leave your heirs life insurance proceeds instead of a house they will end up fixing up and selling anyway.  As I have discussed before, life insurance passes to beneficiaries outside of probate and creditors cannot touch it.  If the elderly parent is in money trouble, and they charge a lot to credit cards, those creditors WILL come after estate assets when the parent passes away and could even force the sale of the house.
 
Con:  If the owner is already receiving government assistance based on income (like Medicaid), the influx of cash from a reverse mortgage could affect those benefits.  Social security, Medicare, and pensions typically aren’t affected.
 
Pro or Con, depending on the circumstance:  Anyone getting a reverse mortgage really needs to be okay with the fact that their children are probably not going to inherit the home.  There are closing costs added to the loan, and then interest is charged against that.  Even if the entire mortgage proceeds are not used (which is highly doubtful, as most homes are mortgaged, and the point of a reverse mortgage is to give you access to cash), the balance is going to grow and grow each day.  The balance could grow to exceed the equity, and then when the house is sold, there may be nothing left.
 
However, it is possible that the house could be sold[2] while there’s still equity in the home (more equity than what is owed on the reverse mortgage).  For example, in our $300,000 example, if the borrower had only used $10,000, there may be more equity in the home than what is owed. The borrower could sell the home, pay off the bank, and keep the remaining equity.  If the borrower passed away, the bank will give the family 6- 12 months to sell the property, pay off the loan, and then the beneficiaries can keep the remaining proceeds.  If a family member is really interested in the family home, they could purchase the home or pay off the mortgage.
 
Realistically, this probably wouldn’t happen. The temptation to use the reverse mortgage proceeds is high.  People are living longer, things are getting more and more expensive (including medical care), and with interest accruing on the loan, it’s likely there won’t be anything left.  So a borrower must be okay with the bank taking their home when they pass.
 
Pro:  In the event that the borrower dies owing more on the reverse mortgage than there is equity, the borrower’s estate is not responsible for the deficiency.  Again, if someone passes away owing credit card debt, those types of creditors are allowed to come after estate assets.
 
Con: The bank will “call” the loan when the last owner moves out or moves into a nursing home.  This is the biggest con, in my opinion, and there are three reasons:
 
(1) If there is any money left in the line of credit, at the time they enter the nursing home, the owner doesn’t get to keep that line open.  If that person wants to use that money, they would need to draw the full amount of that line of credit before leaving the residence because the bank will take the house and there may not be any equity for you to receive after the line of credit is paid off.  However, a person would not want to do this if they owe very little, because they will receive the equity after the bank sells the property.
 
(2) If the borrower has a lot of spare cash due to the reverse mortgage proceeds, or if the borrower gets a lot of equity proceeds after the bank sells the house, they may no longer qualify for Medicaid assistance for the nursing home.  If it is likely that a potential borrower may need nursing home care in the near future, and they currently qualify for Medicaid, a reverse mortgage may not be a good option.
 
(3) The borrower could end up in a situation where the reverse mortgage proceeds have been spent, and there’s no money for the nursing home.  The bank could take the home and the borrower not get any equity proceeds.  If the borrower has no money saved up and no long term care insurance, they may not be able to pay for the nursing home and would have to rely on qualifying for Medicaid.  Thus, careful planning is needed.  Someone considering a reverse mortgage should use a portion of the proceeds to plan for the contingency that they may need long term care. 
 
In conclusion, a reverse mortgage can be an excellent tool to create cash for older individuals while allowing them to remain in their home.  However, there are serious consequences.  A person considering a reverse mortgage should consult with a financial advisor and estate planning attorney to help them make their decision.  The planning may be different depending on the borrower’s situation.  Children and people with power of attorney also need to be somewhat involved, in case they need to assist an aging parent with mortgage proceeds or nursing home arrangements down the road.  Please give me a call if you would like more information. 
 
 
[1] He can be reached at [email protected].

[2] There’s no prohibition against selling a home with a reverse mortgage.