Realtors wise to be schooled in reverse mortgage pitfalls before recommending to clients

Homeowners who've recently lost spouse are often in dire financial straits

Reverse mortgage image via Shutterstock.Reverse mortgage image via Shutterstock.

When many seniors lose their spouse, they can no longer afford to keep their home on a single retirement income. One of the greatest services that you can provide as a Realtor is to help that senior continue to stay in that home if at all possible.

Reverse mortgages have gained a reputation as being dangerous tools that can cost someone their property or that can be used to scam unsuspecting seniors. The truth of the matter is that some of these statements are true, but there is another side to this story that every practicing Realtor needs to understand.

I recently met Mike Banner, national education director for Security One Lending, who asked me if I had ever heard of a reverse purchase mortgage. Of course I knew what a reverse mortgage was, but using one to purchase a new property?

Banner went on to explain that when he trains on how to use the various types of reverse mortgages, most agents’ eyes just glaze over. Before discussing how seniors can use a reverse mortgage to purchase property, it’s important to understand how these mortgages work in general. From the HUD/FHA Reverse Mortgage Program:

“A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that you built up over years of making mortgage payments can be paid to you. However, unlike a traditional home equity loan or second mortgage, HECM (Home Equity Conversion Mortgage) borrowers do not have to repay the HECM loan until the borrowers no longer use the home as their principal residence or fail to meet the obligations of the mortgage.

“You can also use a HECM to purchase a primary residence if you are able to use cash on hand to pay the difference between the HECM proceeds and the sales price plus closing costs for the property you are purchasing. …

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“To be eligible for an FHA HECM, the FHA requires that you be a homeowner 62 years of age or older, own your home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan, and you must live in the home.”

When someone loses their spouse and the estate was not set up properly, the survivor may have to pay capital gains tax on the amount of the gain ... [and could end up] losing his or her home."

How to help mom keep her house

A reverse mortgage can be a godsend for a senior who is struggling to pay for medications, food and other necessities. When someone loses their spouse and the estate was not set up properly, the survivor may have to pay capital gains tax on the amount of the gain. Since he or she often doesn’t have the savings or other income necessary to pay the obligation, the survivor ends up losing his or her home.

This is where a reverse mortgage can be a wonderful way to let the surviving spouse meet the tax obligation, have no mortgage payments, and still stay in the property. The interest due on the loan is simply tacked on to the principal. Interest rates are slightly less than conforming fixed and adjustable financing.

The purchase reverse mortgage

While most agents are familiar with the scenario above as an important option for helping seniors, many agents are unaware that seniors can also use a reverse mortgage to purchase a new residence. The amount you can borrow is based upon your age, since the payout on the reverse mortgage works much the same as an insurance policy. In other words, the amounts are based upon an actuarial tables rather than the borrower’s ability to repay the loan.

Assume that your clients have just sold their big home and have $500,000 in cash. They would like to buy a condo near where their kids and grandkids live; however, they can’t afford to pay the $600,000 it would take to purchase in this area. Here’s how a purchase reverse mortgage would make this work:

1. Purchase price is $600,000 with $300,000 down and a $300,000 new reverse mortgage. As with other reverse mortgages, there is no income verification. Instead, the mortgage is based upon the borrower’s age, down payment, and the value of the property.

2. After the property closes, the monthly interest payment is added to the principal amount. In other words, the loan has negative amortization.

3. When the owner(s) die, the loan is paid off and any remaining equity goes to the deceased owner’s estate.

One of the most interesting observations that Banner shared was that when seniors use a reverse mortgage to purchase new construction, they often use a portion of the extra cash to purchase upgrades that they normally would not have considered before.

Pitfalls

While a reverse mortgages can be highly beneficial, there are some serious downsides.

1. Property must be owner-occupied
One of the stickiest situations occurs when the owner who has a reverse mortgage becomes ill and must be in a long-term care facility for an extended period of time. At what point does the owner no longer meet the occupancy requirements and have to sell?

2. Reverse mortgage acquired before both spouses are age 62
One of the most common ways that mom can lose the house occurs when dad obtains a reverse mortgage and mom isn’t old enough to go on the loan. If this occurs and dad dies first, mom would have to probably liquidate the property to pay off the reverse mortgage unless there was sufficient equity for her to acquire a new reverse mortgage.

Reverse mortgages can be a real blessing to a senior who may be facing the loss of his or her home due to illness, loss of spouse, or other issues. Avoid reverse mortgages where the term of the loan is based upon 15 or 20 years rather than the borrower’s death date.

If you have clients who are 62 or older, have at least a 50 percent down payment, and are willing to accept negative amortization, they can purchase the retirement home of their dreams with a reverse mortgage. Best of all, there are no payments and no qualification making this an ideal way to let mom keep her home or purchase something new if she wants to move.

Bernice Ross, CEO of RealEstateCoach.com, is a national speaker, trainer and author of the National Association of Realtors’ No. 1 best-seller, “Real Estate Dough: Your Recipe for Real Estate Success.” Hear Bernice’s five-minute daily real estate show, just named “new and notable” by iTunes, at www.RealEstateCoachRadio.com.

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