Is a Reverse Mortgage a good choice for seniors, or are there other options?

Jon Beyrer, CFP, EA

Reverse mortgages are being used by more and more retired homeowners to fill the gap between their income sources and their required spending. For some homeowners, a reverse mortgage may be the best way to provide income or to pay off debts or expenses. However, senior homeowners have other alternatives available to them that may make more sense than a reverse mortgage, depending on their particular goals and situation.

The following alternatives may be preferable to a reverse mortgage in some cases:

• A “cash–out” traditional refinance 
• A charitable home remainder annuity
• Selling the home and either downsizing, renting, or buying into an assisted living facility

What is a Reverse Mortgage?

A Reverse Mortgage is a loan product that allows the homeowner to pull out a lump-sum or stream of income from part of the equity in their home. The reverse mortgage lender receives neither principal nor interest payments during the life of the loan. If the homeowner passes away, or vacates it for over a year, the house is sold and the lender receives the principal plus the accrued interest from the proceeds of the sale. If the house sells for more than the reverse mortgage balance, the homeowner or the heirs receive the difference. If the homeowner dies and the house sells for less than the balance, the lender takes a loss.

Who Can Get a Reverse Mortgage?

Homeowners who are age 62 or older are eligible for a reverse mortgage. The homeowner doesn’t have to qualify based on income or credit like a traditional mortgage. However the home must be in good condition, and the homeowner must have paid off their existing mortgage loan, or at least have the loan balance paid down substantially. Most reverse mortgage loans allow for an initial draw that may be used to pay off the balance of the existing lien.

What are the advantages of a Reverse Mortgage?

The advantages of a Reverse Mortgage are:

• The homeowner doesn’t have to make payments on the loan The income or lump sum they receive is not taxable
• The homeowner can live in the house for the rest of his or her life, even if the loan principal and interest grow to be more than the value of the home
• The lender cannot force the homeowner out of the home while they live there
• The homeowner can sell the home and pay off the reverse mortgage
• After the homeowner passes away, the equity left over after paying off the reverse mortgage goes to the heirs

What are the Disadvantages of a Reverse Mortgage?

Disadvantages of Reverse Mortgages may include:

• High up-front costs (as high as two percent of the loan amount).
• High ongoing costs (mortgage insurance and servicing fees). 
• Risk of interest the rate increasing (reverse mortgage rates are always adjustable) 
• Lump sum proceeds may affect eligibility for Medicaid

What Issues Should be Considered before Deciding on a Reverse Mortgage?

Before deciding to take out a reverse mortgage, homeowners should consider the following issues:

• Are other retirement income sources available for the homeowner? 
• Would downsizing or taking a cash-out refinance make more sense?
• Is it the homeowner’s goal to bequeath the house or to leave assets to heirs?
• Is the Reverse Mortgage lender reputable, and are the fees and interest rate reasonable?
• Would receiving a lump sum affect Medicaid or other benefits?

What is a Cash-Out Mortgage?

A cash-out mortgage is a traditional mortgage, with payments due each month. The homeowner receives a lump-sum which can be used to provide income and to pay off debts or expenses. Cash out mortgages are available with a variety of terms: fixed or variable interest rates, interest-only or negative amortization, and various different lengths.

When is a cash-out mortgage a better choice than a Reverse Mortgage?

If the homeowner can qualify for a traditional mortgage, the homeowner may be able to save substantial amounts of interest, fees and costs by taking out a traditional mortgage. If interest rates are reasonably low and the homeowner chooses a fixed interest rate, she can eliminate the interest rate risk of the reverse mortgage. This may substantially increase the amount of equity left over for heirs or for the homeowner if entering a nursing home or assisted living facility.

When is a cash-out mortgage not a better choice than a Reverse Mortgage?

The primary disadvantage of the traditional mortgage is that payments are due each month. This may be a burden or a stressor for the homeowner. The homeowner also has to decide how to manage the lump sum received so that it provides income. Also, the mortgage proceeds may affect eligibility for benefits such as Medicaid or other programs that have an assets-based eligibility.

What is a Charitable Home Remainder Annuity?

A Charitable Home Remainder Annuity is a contract made with a charitable organization, whereby the homeowner essentially wills the home to the charity in return for an annuity during the homeowner’s life. The homeowner retains a life interest in the home, so as long as she is alive, she can remain in the home. The homeowner receives a tax deduction for the charitable gift. Heirs typically receive none of the home’s value at the homeowner’s death.

When is a Charitable Gift Annuity a better choice than a Reverse Mortgage?

In order for a charitable annuity to make sense, the homeowner must have the primary objective of leaving a substantial amount of assets to a particular charity. If that is the case, the tax benefits of a charitable annuity will allow more assets to flow to the charity and less to the government. Depending on the homeowner’s age and prevailing interest rates, the homeowner may receive a favorable income stream based on the remainder value of the home. As an example, the income on a charitable remainder annuity for a $500,000 house may be $2,000 a month or more for life, and the charitable tax deduction may substantially reduce the taxability of the income.

What Should I do to Decide if a Reverse Mortgage is Best?

Find out more information on reverse mortgages by:

• Visiting the website of the US Department of Housing and Urban Development (HUD) www.hud.gov.
• Attending a free reverse mortgage counseling session offered by a HUD-approved mortgage counselor. For a list of these counselors, go to http://www.hecmresources.org
• Find out more about the traditional alternative by talking to a bank or mortgage lender and obtaining a quote for the interest rate, fees, and monthly payment.

If a charitable annuity is a possibility, discuss it with the charity or a regional charitable organization that can act for the charity.

Jon P. Beyrer, EA, CFP® is the Vice President of Financial Planning at Blankinship & Foster, LLC, a Registered Investment Advisor in Solana Beach, California. Mr. Beyrer earned his Master of Science Degree in Financial and Tax Planning from San Diego State University. He is licensed to use the Certified Financial Planner and CFP marks by the Certified Financial Planner Board of Standards, and is enrolled to practice before the Internal Revenue Service. Mr. Beyrer is a member of the Financial Planning Association and currently serves as the association's Public Relations Director. He is also a member of the La Jolla Estate Planning, Trust and Probate Section and the National Association of Personal Financial Advisors.