Reverse Mortgage - A Last Resort? - 3/1/2004 - Mortgage Loan Refinance Debt Equity

Reverse Mortgage: A Last Resort?
by Benny L. Kass

Question: My mother-in-law is 80 years old, in good health, and lives in a condominium. She has a $50,000 mortgage with a 7.5 percent interest rate and 15 years to go before it will be paid off. I am considering suggesting that she refinance with an adjustable 5- or 7-year mortgage, or alternatively that she obtain a reverse mortgage. What do you suggest?

Answer: There are a number of options available to you and your mother-in-law, but obviously only she can make the final decision as to what is best for her. However, whatever approach you take, you should seriously consider getting rid of that 7.5 percent mortgage while interest rates are still low.

First, have you considered buying the property from her? Let's assume that the condominium unit is worth $250,000. If you can qualify for a loan, you can obtain a new mortgage in the amount of $50,000, which would pay off her existing loan. The balance of $200,000 could either be given to her directly on the date of sale (assuming you have this cash available) or, better yet, you can pay her off in reasonable monthly installments. You can then rent the property back to her for little or no rental income. In my opinion, this would be the best approach to take.

Second, have you considered the possibility of obtaining a new mortgage for her, and also getting a home equity loan (also known as HELOC). In our example, the property is worth $250,000 and there is a $50,000 mortgage. Thus, the difference -- called equity -- is $200,000. Most banks will be happy to give your mother-in-law a home equity loan of up to 80 percent of this equity, or in your case $160,000. It is my opinion that every homeowner should have a home equity loan.

Why? Because in most cases, banks will either not charge for such a transaction or the cost will be minimal. The great advantage of a HELOC is that you do not pay any interest or principal on the loan until you use the money. You have a checkbook that you keep in your desk drawer until you need the money, and then you will start having to pay monthly interest on only that portion of the loan which you have drawn upon.

A third alternative is a reverse mortgage. A mortgage (called a Deed of Trust in parts of the country) is a loan made by a mortgage lender either to enable a person to buy a home, or to refinance an existing mortgage. A reverse mortgage is a sum of money lent by a financial institution to homeowners -- usually those over the age of 62 -- based on the existing equity in their home.

Reverse mortgages became popular in the mid-1980's. Many recently retired homeowners suddenly found themselves with a house free and clear of debt, but with little or no savings with which to enjoy life after retirement. In popular terms, these homeowners were "house rich but cash poor."

Lenders came up with the concept that these homeowners could borrow money based on the equity in their house. Instead of the homeowners paying a monthly mortgage to the lender, the lender would either advance them a lump sum -- not more than 75-80 percent of the equity in their home -- or would send the homeowner a monthly check.

What was the catch? When the homeowners died, or no longer lived in that house, it would be sold and the lender would get repaid from the sales proceeds.

But how much would the lender get?

Although most legitimate lenders would require that the repayment be based on an interest rate -- such as one or two percentage points above the general average -- there were too many instances where homeowners were taken advantage off by unscrupulous lenders. In addition to a higher than normal interest rate calculation, some lenders were requiring that they receive a sizable percentage of the sales price (called an "equity share").

Thus, many homeowners learned that the home (or the equity in the home) which they planned to leave for their children and grandchildren had been greatly diminished.

Fortunately, many of these problems have now been corrected.

According to Peter Bell, President of the Washington, D.C. based National Reverse Mortgage Lenders Association (NRMLA), "Fortunately, many seniors are sitting on the answer to their problems -- their home. By getting a reverse mortgage, where appropriate, seniors can take care of their own needs and live more comfortably, and ease their kids' concerns as well." Let's go back to your situation. The equity in your mother-in-law's home is approximately $200,000. Thus, the maximum she can borrow from a reverse mortgage lender would be 80 percent of the equity -- or $160,000. Depending on the reverse mortgage lender she chooses, there are several payment options:

 

• Get all the cash up front;
• Get a line of credit which allows her to write checks up to the limit whenever she needs the money, or
• Begin receiving a monthly annuity, in an amount mutually acceptable to her and the reverse mortgage lender.

What's the catch? That depends on the terms of the loan and the legal documents she will be asked to sign. It is very important that her financial and legal advisors get involved in this transaction before she signs any legal papers.

If your mother-in-law obtains such a reverse mortgage, she will not have to make any loan payments during the term of the loan. But read the fine print of the mortgage documents carefully; is there a term limit to this loan? Most legitimate lenders will only require that their loan be repaid when you permanently move out of the house (which includes both husband and wife), or when the house is sold.

The money received from a reverse mortgage can be used for any purpose. However, the lender will want to inspect the property and if it determines that certain improvements must be made (called "mandatory repairs") a portion of the money that is borrowed will have to be earmarked for these repairs and you will be obligated to complete them in a timely manner.

In addition to the mortgage interest that the lender will ultimately collect, there will be some up-front costs. Typically, these would include an origination fee -- points -- which can be financed as part of the mortgage, a credit report, an appraisal and similar charges which any borrower or refinancer would have to pay for settlement costs.

While the money received from the reverse mortgage lender is tax free (since all you are doing is borrowing from your own equity), you should be aware that such a mortgage may impact on eligibility for other kinds of governmental assistance -- such as health benefits. That is why most legitimate reverse mortgage lenders will require the borrower to obtain counseling before they make the loan.

According to the NRMLA, there are five steps in the process of obtaining a reverse mortgage loan:

 

1. Awareness. You learn about this type of loan from columns like this;
2. Action. You then seek more information, either from a lender, the Department of Housing and Urban Development (HUD), or the AARP;
3. Counseling. Most reverse mortgage lenders will require, as a precondition for the loan, that you go through special education counseling. You must understand that there are risks involved with a reverse mortgage; you must also recognize that -- as discussed earlier -- there are other options available to you, which may not require that you give up part of your equity when the home is sold.
4. Application/Disclosure. Once you have completed the steps listed above, you will make an application for the reverse loan and select the option you wish to take. The lender is then legally required to disclose the estimated total cost of the loan; this is mandated by the Federal Truth in Lending Act. Once you receive these disclosures, you should shop around to see if other lenders can offer you a better deal.
5. Processing. After you decide whether you want such a reverse mortgage, and if so which lender you will use, your lender will process the application, obtain a credit report and an appraisal of the property, and also determine if there are any mandatory repairs which must be made.

Then, if all goes well, you will have your reverse mortgage.

But, you must consider all available options before the final decision is made.

For more information about Reverse Mortgages, go to www.seniorsafehome.com or call the NRMLA at (866) 264-4466 for their free booklet entitled Guide to Aging in Place.