Copyright Healthcare Financial Management Association Jun 1999A reverse mortgage can provide cash to homeowners who do not want to move but would like to tap the equity in their home. Reverse mortgages have grown in popularity since the Federal government and the 
Federal National Mortgage Association (Fannie Mae) began offering insured home mortgage programs several years ago. By participating in an insured home mortgage program, homeowners continue to receive all the money due them under the program, even if the lender defaults.
With a reverse mortgage, a lender makes a loan against the appraised value of a home. The loan amount is unrelated to the borrower's income or creditworthiness. Instead, it is based on the value and location of the home, the age of the borrower, and the participating lender.
The borrower chooses to receive the loan amount as a lump sum; a line of credit, which can increase over time, depending on the program; or monthly payments. Monthly payments usually last only until the borrower moves, unless the payments take the form of an annuity. A person concerned about outliving the cash in a credit line or contemplating a future move should consider an annuity option. In some cases, the payment received under the annuity option would be substantially more than a monthly loan advance.
In most cases, when the borrower moves or dies, the loan plus any accrued interest must be repaid from the proceeds of the sale of the property or from other available sources. The annuity option, however, requires repayment only at the expiration of the annuity term, typically when the borrower or the last of the coborrowers dies, regardless of where they live.
A reverse mortgage is secured only by the borrower's home. No other assets are at risk if the property's value declines after the loan is granted. In addition, with most reverse mortgages, borrow,ers' lack of equity in their homes cannot be used as a basis for forcing them out of their homes.
Reverse mortgages should be considered when the homeowner needs cash to meet the rising cost of living; avoid having to move from a cherished home; maintain the home or pay property taxes; or cover home health care, long-term care insurance, or other health-related costs. In many cases, using cash from a reverse mortgage can help a person avoid moving to a nursing home.
Before committing to a reverse mortgage program, homeowners should consider other options, such as simply selling the home and trading down to a less-costly residence. Investing any excess cash resulting from the home sale in a diversified portfolio could help satisfy ongoing cash needs.
The 1997 Taxpayer Relief Act raised the capital gains exclusion for a principal residence to $250,000 per taxpayer ($500,000 for a married couple filing jointly), provided the residence was owned and used as one's main home during two of the five years preceding the sale. This law should lessen the tax burden for homeowners who sell their home and trade down. In addition, although homeowners can use the new home-sale exclusion only once every two years, it is even available to taxpayers who previously took advantage of the former $125,000 exclusion for home sellers age 55 and older.
Another reasonable alternative to a reverse mortgage is for a parent or grandparent to borrow money from a child at a rate lower than that a reverse mortgage lender would charge. The borrower, however, should be mindful of the "below market loan" rules, which recharacterize as arm's length loans that carry little or no interest between family members.
Limitations
The reverse mortgage amount available depends on the borrower's age, the home's value, and the interest rate on the loan. As of March 12, 1999, the "maximum claim amount" of the FH-Is Home Equity Conversions Mortgage (HECM) ranges from $115,200 to $208,800, depending on geography Participants can borrow 30 to 80 percent of this amount, with the amount varying according to the borrower's age. This amount grows over time if the home's value appreciates. The Fannie Mae HomeKeeper program loan limit goes up to $240,000 but does not increase over time unless the borrower opts for an equity-sharing option, which is essentially a fee equal to 10 percent of the home's value at the time of maturity. To borrow more than $240,000, one would have to use a private lender.
Exhibit 1 (page 84) compares the amounts available to a hypothetical 75-year-old homeowner living in Cook County, Illinois, under the HECM and HomeKeeper reverse mortgage programs. Exhibit 2 (page 84) compares the maximum current credit line available (also equal to the amount available as an immediate lump sum) for a series of Maryland homeowners whose current ages range from 65 to 85. For both exhibits, the estimated current value of the home is $150,000.
The amounts listed in Exhibits 1 and 2 were calculated using software posted on the National Center for Home Equity Conversion (NCHEC) Web site (www.reverse.org). These amounts are based on interest rates in effect the week of February 8, 1999, and approximate national average closing cost and maximum financable origination fees, that is, fees that could be added to the loan amount other than closing costs.
Qualifications
Although requirements vary across programs, the following are typical:
Homeowners must own their home and be at least age 62;
The home must be one's permanent residence (occupied for at least half the year);
The programs typically cannot be used by owners of co-ops or mobile homes;
There must be no outstanding debt secured by the home; and
To qualify for the FHA program, one's home must be a single-family property, a two-to-four-unit building, or a Federally approved condominium or planned unit development. For Fannie Mae, the home must be a single-family home or condominium.
Other Considerations
A reverse mortgage can pose risks to homeowners. For example, if a homeowner sells the home within a few years of getting the loan, the loan becomes extremely costly when all closing costs and fees are considered. Reverse mortgage programs are more appropriate for homeowners who intend to stay in their current home. On the other hand, if a borrower has a reverse mortgage for many years and then contemplates a move, there may be no home equity left with which to purchase a smaller home. Getting a reverse mortgage may be tantamount to deciding never to move, unless it is to a nursing home or senior citizen residence.
The out-of-pocket costs for a reverse mortgage are nonexistent or negligible because closing costs and fees are added to the amount loaned. All lenders must disclose the total annual loan cost (TALC) for reverse mortgages, which allows applicants to compare similar programs accurately. But the math can get confusing. Although the TALC interest rate may seem excessive for short-term loans, this rate declines steadily over time. TALC rates differ from annual percentage rates because the former include all costs and assume the borrower will not take the loan amount in a lump sum at the closing.
Cash received as part of a reverse mortgage program does not reduce Social Security or Medicare benefits. Supplemental Security Income (SSI) or Medicaid benefits, however, may be reduced by such disbursements, depending on the circumstances. Thus, the rules regarding eligibility for such programs should be reviewed before closing a reverse mortgage deal.
In general, reverse mortgage proceeds are not included in the borrower's gross income. Annuity-type payments, on the other hand, may be partially taxable. Also, the interest on the amounts loaned is not deductible until it is paid, which would normally occur only upon termination of the loan (eg, after the borrower's death).
For more information and a list of preferred mortgage lenders, call the Department of Housing and Urban Development's Housing Counseling Clearinghouse at (800) 2176970 or Fannie Mae at (800) 7326643, or visit the NCHEC Web site.
| [Author Affiliation] |
| William G. Kistner, MM, CPA, is a tax partner, Ernst & Young LLP, Chicago, Illinois, and a member of HFMA's First Illinois Chapter. Readers' comments should be addressed to him at Ernst & Young LLP, 233 South Wacker Drive, Chicago, Illinois 60606-6301. |
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