Q: Our parents own their house free and clear, and it is worth about $400,000. Dad is 79 and Mom is 77; both are in fairly good health. They receive Social Security and a modest monthly pension. We would like to assist them financially. They both like to travel, but their limited resources deny them this pleasure. Do you have any suggestions?
A: You and your parents should consider a reverse mortgage — either from a commercial lender or privately from you. Here’s how such a mortgage works. Someone who is 62 or older and owns a house that is fully paid for or has a relatively low mortgage can be a candidate for a reverse mortgage. Unlike a regular (or forward) mortgage, where you have to make monthly mortgage payments, with a reverse mortgage you borrow money, but do not have to repay the loan until you either sell the property or die. At that point, the lender is repaid the principal and all of the accrued interest. The lender cannot foreclose on the property or in any way interfere with ownership, unless the owner is causing waste or damage.
There are three forms in which a homeowner can get this money, which is tax-free because it is from the equity in the house:
- single lump sum of cash;
- line of credit so that the money is available as and when it’s needed; or
- monthly cash advance.
There are a number of reverse-mortgage programs available. Perhaps the most popular is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration. This is the only reverse mortgage that the federal government insures.
To be eligible for the HECM, all owners of a home must be at least 62, must use the home as the principal residence, and cannot be delinquent on any debt to the IRS. The home must either be a single-family residence, or a one- to four-unit building. Some condominium units that have received approval are also eligible. Cooperative apartments and most mobile homes are not eligible.
How much money can homeowners take out? That depends on a number of factors, including ZIP code, age and the current appraised value of the property. There’s a handy calculator on the Internet at www.rmaarp.com, a site run by AARP, the senior citizen group.
Another program available to homeowners is called the Home Keeper; it is sponsored by Fannie Mae. Although it is similar to the HECM, there are some differences. For example, the loan limits for the HECM will vary depending on the location of the house; Home Keeper loans are limited only by the Fannie Mae guidelines. If a borrower opts to take the money as a line of credit, the unused portion of that line can increase over time with the HECM but will remain fixed with the Home Keeper.
Both these reverse mortgages have loan limits, which are set annually by the various agencies. For example, Fannie Mae’s loan limit currently is $417,000, while HECM will lend up to $362,790.
If a homeowner wants more money, there are lenders who will make those larger loans, too. The National Reverse Mortgage Lenders Association has a Web site, www.reversemortgage.org, with contact information for lenders active in each state. That site also has a lot of other information about these mortgages. The AARP’s reverse-mortgage site can also help you find lenders.
These, of course, are all details. Should your parents decide that a reverse mortgage fits their needs, they should carefully research all the available products to determine what is best for their personal needs.
Keep in mind that any reverse mortgage will carry a higher rate of interest, and will have high closing and servicing costs. These can either be paid up front or rolled into the amount of the loan.
Consumer counseling is mandatory before homeowners can borrow under either the Home Keeper or the HECM arrangement. This is free, and takes about an hour. The lenders — and the government — want to make sure that the homeowners need such a loan, understand all the terms and conditions, and are fully competent and qualified.
Consumers are still hesitant about reverse mortgages. Many of us want to make sure that our children will inherit the house that we struggled so hard to buy and maintain over the years. We do not want some lender to take our hard-earned equity.
But realistically, many homes are sold when the parents die. And estate and inheritance taxes often eat up some of this equity.
That is where you, the adult children, come in. Instead of having your parents go to a commercial lender, can you afford to be the private lender? Say your parents want an extra $2,000 a month. They can enter into a line of credit arrangement with you. They would sign a promissory note that is secured by a deed of trust (a mortgage) on the property.
The terms can be similar to those a commercial lender requires, but because this is family, the closing costs can be nominal. The deed of trust must, however, be recorded among the land records where the property is located. And the interest rate must be consistent with what a commercial lender would charge, or there could be tax complications.
What are the benefits to this?
From your parents’ point of view, they keep everything in the family. They are, in effect, borrowing money from their children instead of a stranger. When the loan is finally paid off — either because your parents sell the house or die — they or their estate can deduct all the interest payments.
And during their lifetime, your parents do not have to pay you anything. The interest just continues to accrue. Your parents can also use this money to buy additional life insurance, which will help with any taxes that the estate may be obligated to pay.
You get significant benefits also, although when you finally get paid, you will have to declare the interest as taxable, ordinary income. The loan on the property will reduce any estate taxes that must be paid when your parents die. And because you will inherit the house, you get the stepped-up basis for tax purposes.
In my opinion, a private reverse mortgage is a win-win situation. Your parents get the extra money they want, and you help them do this without losing any taxable benefits or straining your own budget.
There are a number of excellent publications on the Internet that will guide you through the process. Try AARP, Fannie Mae (search for Home Keeper) or the Department of Housing and Urban Development (search for reverse mortgage).
Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to [email protected].