What do you do if you have a fully-paid off house when you retire but you don’t really want to live in it anymore? It may sound like an odd question, but this is more or less the situation that’s facing my parents. They are living with my brother and his family in order to be closer to their grandchildren (both his daughters and my son). At the same time, their fully-paid off home down south is such a minor cash drain that they have yet to sell it even after a couple of years living away from it.
They aren’t interested in selling it or renting it out. My father looked into renting, and even had some discussions with people who were looking, but that fizzled out after the money just didn’t justify the remote landlord headaches. They don’t want to sell since they do spend some time in the summer and at holidays there to visit friends. So what’s a good option? What about reverse mortgages?
Basically a reverse mortgage is just what it sounds like. You, in effect, become the lender and the bank becomes the home buyer. The bank pays you interest and principal and takes ownership of the home when the mortgage term finishes. There are a few rules:
- You must be at least 62 years old for a bank to consider you.
- You must live in the home
- You must have no mortgage, or a mortgage that you can easily pay off at closing (I am not sure exactly how that is measured, but effectively you must have very few mortgage payments left).
- With a few exceptions, your home must be a single-family dwelling. Condominiums may or may not be eligible; some multi-unit dwellings would be eligible but you would have to live in a unit.
If you qualify, the bank will pay you based on a schedule you determine. The older you are, the better terms you will get. The payments can be tenure (as long as you or your spouse inhabits the home), term (a set number of months) or line of credit (similar to a home equity loan, where you could withdraw money as you need it in any amount). The bank will not kick you out of the house even if you outlive the reverse mortgage, and if you die before the bank pays the entire amount, the bank will pay the balance to your estate – less fees, of course.
So why do banks offer this? Well, cynically, they want you to lock in a sales price and die before the bank pays you the entire amount of the reverse mortgage. Your inheritors will very definitely not get the house in any circumstance. The value of the reverse mortgage is going to be less than the value of the house were you to sell it – the bank is effectively going to net out some rent for allowing you to live there. The costs of a reverse mortgage are very high, although these costs can be ‘buried’ in the closing. The banks will definitely make money off a reverse mortgage. They are buying your home at a discount, locking in the price, and gambling that you will pass away quickly so they can resell it. If you live longer, they still win. How? Imagine being 90 years old with your reverse mortgage expended and needing to refinance a new traditional mortgage. In that situation, many older people would probably do whatever the bank told them to do.
So is it a good deal? I think there are a very limited set of circumstances where a couple would look into a reverse mortgage. My parents, despite being younger than 62, might have some good reasons to get one. They do not really want to sell the house, yet my brother and I are not interested in inheriting it 40 years from now. We like it well enough but we have the same reservations about remote landlording they do. They do not particularly need the money, although it would be nice to get some value out of the house. The only problem would be whether a bank would look at a one-month stay per year as “living in the house” or not.
I think a reverse mortgage, as with any product targeted to seniors, has to be taken with a grain of salt. The advantages of a reverse mortgage might be worth it for an elderly couple who have no children or do not intend to pass on their home, but they would need to be careful that the extra income did not interfere with Medicare or Social Security payments. As with a traditional mortgage, there are also many costs associated with closing the deal that can be far more expensive at the end, when all of the details are crushing in at once, than they appear to be at the beginning. The rising popularity of reverse mortgages and the continuing shift in the American view towards thinking of their homes as ATMs mean that whether or not you think this makes sense for your parents or yourselves, you will probably have one pitched to you at some point in the future. When you are older and maybe worried that you did not sock away quite enough in the 401(k), it may be a tempting offer, so you should at least understand what the banks are offering you.
Note: After I wrote this, I received an email from Craig that clarified a few points. For the sake of trying to present the best possible information I’ve included the relevant paragraphs from his email here:
When the last person on the deed leaves the house, the bank does not take the house. The amount due to the bank, is the balance due. This includes total draws plus interest/fees that have accrued. Any remaining equity will go to the borrowers or in the event of their death, the children or the heirs will receive the equity.
Lastly, the loan is a non recourse loan. The lender payback is limited to the collateral and the borrower is not personally liable for payment. The senior can never owe more than the value of the home. In the event the balance due ever exceeds the value of the home, the FHA mortgage insurance will take care of the difference. This means that the children/heirs will not inherit any debt. This is unique to the Reverse Mortgage Program. No other mortgage product offers this protection.