Reverse Mortgages
A Tax-Free Way to Fund Life Insurance and Long-Term Care Insurance Premiums
by Celia j. Mason, JD, CSA
In the course of estate planning, many higher net worth clients discover that they will have a significant estate tax -liability. A reverse mortgage may be a viable alternative to create liquidity for clients who are 60 or older. They may want to set up an irrevocable life insurance trust (ILIT) to purchase a life insurance policy, but do not have readily available cash to pay the premiums. Other clients want to contribute to a favorite charity, but don’t want to sell their real estate when the market is low or want to include long-term care insurance into their financial plan.
One way to create cash is to take distributions from their deferred retirement accounts, if they have them. But, they would have to pay taxes on their withdrawals. They would have to take out $1.40 or more for every $1.00 they needed, thereby depleting their investment accounts significantly.
Some recent developments in the reverse mortgage industry have created new options for the house-rich, cash poor homeowners. One lender even introduced a loan for 60-year olds to tide them over until they can qualify for the traditional reverse mortgage at age 62. This loan has low costs, but offers smaller loan amounts.
Many large corporations are jumping on the reverse mortgage bandwagon as the first Baby Boomers turn 62 this month. There are more alternatives to the home equity conversion mortgage, which the Federal Housing Administration (FHA) introduced in 1989 to standardize and regulate the industry.
The FHA loan meets the needs of 95% of homeowners across the United States, but meets the needs of a smaller percentage of California homeowners. The reason is that these loans are calculated on a maximum county lending limit, which is $362,790, in 2008. Any home value higher than the limit is disregarded when calculating the maximum loan amount. In response to this need, the lenders are offering a variety of jumbo loans, so that borrowers can have access to more cash. They are also offering loans that can be used to purchase a new home and loans on second homes and investment properties.
Remarkably, one lender is even offering a financial instrument that will give 65 to 85-year old homeowners some of their equity in cash without requiring that the money be paid back, ever. However, the borrower must give up some future appreciation and be healthy enough to qualify for a life insurance policy. A borrower who can qualify for a lender-paid life insurance policy should qualify for their own policy to replace the appreciation that they are giving up. Some of the cash they receive can be used to make the premium payment and pay for that trip around the world.
Now, the basics: A reverse mortgage takes a portion of the equity and converts it into tax-free cash. This money can be used for living expenses, home repairs, healthcare costs, insurance premiums, estate planning, or it can be used to fund their grandchild’s college education. In other words, there are no restrictions. Single-family homes, condominiums, manufactured homes, and one-to-four unit buildings that are -owner-occupied are eligible.
With the traditional reverse mortgage, all borrowers on title must be at least 62. The loan amount is based upon the youngest age, current interest rates, and the appraised value or county lending limit with the FHA loan. The older the borrower is, the more funds are available because their life expectancy is lower and the lender will be paid back sooner.
A reverse mortgage differs from a home equity line of credit or refinance in that the borrower makes no monthly payments and cannot be turned down due to bad credit or low income. A reverse mortgage can stave off a foreclosure as well. The loan is paid off when the last borrower moves out of the house permanently or passes away. The loan is non-recourse, so the house stands for the debt. There is no personal liability to the heirs if the sale proceeds do not cover the loan. The heirs can choose to sell the property to pay off the debt or take out a conventional mortgage if they wish to keep the home. There is no pre-payment penalty and no equity sharing (with the traditional loan). Most importantly, the lender does not go on title and the senior can never be forced to move out.
The client can receive the funds in multiple ways: a monthly payment for as long as they live, a lump sum, a line of credit that can be accessed when needed, or a combination. A typical client is a 76-year old widow living on Social Security. Her house is worth $600,000, which she and her husband purchased 40 years ago for $30,000. She will face a large tax consequence if she sells the house. She really doesn’t want to move, but she needs or wants more cash. If she doesn’t have healthcare issues, she will typically take out $30,000 up front to fix the roof, pay off some bills, and replenish her bank account. Then she will take $1,000 per month in additional income. The rest of the available funds will be left in her line of credit.
Three major types of loans are available: the HUD/FHA home equity conversion mortgage, the Fannie Mae Home Keeper, and a variety of proprietary products with no lending limit. Most clients choose the home equity conversion mortgage since it usually offers more cash than the Home Keeper and has a lower interest rate than the proprietary jumbo loans.
The FHA agreed to guarantee the loans. The FHA promises that payments will continue to the borrowers even if the lender is insolvent. The FHA also promises to make the lender whole if the house sells for less than the amount owed. Of course, these promises come at a hefty cost.
The costs can be more than $17,000 on a maximum home equity conversion mortgage loan. Clients must pay for the appraisal and the rest of the loan processing fees and closing costs, the FHA insurance premium, and the loan origination fee. The FHA receives 2% of the lending limit (in 2008 the amount is $7,255.80). The FHA capped the loan origination fee at the same amount, though many lenders are discounting the fee in order to reduce the costs to the borrowers. All costs can be rolled into the loan, so the client does not have to write a check, except to pay property taxes and homeowners insurance. The loan proceeds will be used to pay off a small outstanding balance on the current mortgage if there is one.
Jumbo loans have much lower fees than does the home equity conversion mortgage, primarily because there is no FHA insurance premium. But they charge a higher interest rate. On the other hand, a client with a house worth more than $800,000 may prefer this loan since it will offer significantly more cash. One 96-year old client, who lived in a $3 million house in Pebble Beach, was able to access more than $2 million for estate planning. She used her $1 million lifetime gift to help her son and his family who were having medical issues.
The other requirement is that all borrowers must receive free counseling from an independent, HUD trained counselor in person or over the phone. The counseling is meant to help the client evaluate their other options and get objective information from a disinterested third party. Family members and trusted advisors are encouraged to attend.
Governor Schwarzenegger recently signed a bill (SB 1609), which requires counseling for all loans in California. Paperwork must be translated into the client’s language (specifically Spanish, Chinese, Tagalog, Vietnamese, or Korean). A lender or broker cannot offer an annuity to the borrower or refer the borrower to anyone for the purchase of an annuity before the loan closes or before the borrower’s right to rescind has expired.
Do you have a senior client who plans to stay in their home for at least three years and has no or a small outstanding balance on their current loan? A reverse mortgage can be a funding vehicle for an insurance policy, a charitable contribution, or a better lifestyle so that the golden years are truly golden. q
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Celia j. Mason, JD, CSA is a financial services professional who specializes in Reverse Mortgages and Long-Term Care insurance. Celia earned her Bachelor’s degree from the University of California and has been a member of the California State Bar since 1979. She began her financial services career in 1997 and has been independent since 2004. For more information, call 925-998-4678, e-mail cmason@celiamason.com, or visit www.celiamason.com.
