The Virtues of Private Reverse Mortgages

By Harry S. Margolis

Banks have been touting the virtues of so-called "reverse" mortgages for many years as a way for cash-strapped seniors to tap into the equity in their homes to meet their expenses, whether simply for day-to-day living or to pay for the increased costs of home care.   

The basic concept of a "reverse" mortgage is that the bank makes payments to the homeowner, rather than the other way around. The payments can be a single lump-sum, a line of credit, or a stream of monthly income. The bank does not have to be paid back until the homeowner moves out or passes away.

Drawbacks of a Reverse Mortgage   

But the bank must be paid back at that time. For a senior who moves to a nursing home, this means liquidating an asset that is non-countable for MassHealth purposes and turning it into a countable asset which must be spent down. In addition, because the bank is advancing money not knowing for sure when it will be paid back, there are high up-front costs to reverse mortgages as well as continuing mortgage insurance premiums. In addition, the Federal Housing Administration's program limits the amount that may be loaned to about half of the equity in the home, which may or may not meet the homeowners needs.   

For these reasons, we have always advised clients to seek out more traditional financing if at all possible, such as a line of credit from a bank.

The Private Option   

There is another alternative to the standard reverse mortgage that in many instances better meets the needs and goals of older homeowners – the private reverse mortgage. This is a private loan, usually from a family member, to the homeowner secured by a mortgage on the senior's home.

Here are some of the advantages for the senior homeowner:

  • It's cheaper. The up front costs of paying an attorney to set up a private reverse mortgage may be as little as 10 percent of the cost of a commercial reverse mortgage. In addition, there are no ongoing mortgage insurance costs.
  • It's cheaper. The interest rate on a private reverse mortgage is set by the IRS each month and is less than the interest rate on a commercial reverse mortgage.
  • There's no limit on what percentage of the home equity may be borrowed.  The ability to tap into more equity in the home can delay the day of reckoning when the senior must move to a nursing home just because there's not enough money to pay for caregivers.
  • It need not be paid back until the house is sold, so if a senior moves to a nursing home, she can keep her house.
  • In addition, the senior can continue to receive payments on the private reverse mortgage if needed to maintain the house or to pay for extra care in the nursing home – even to pay for family members to come visit.

Here are some of the advantages for family members:

  • What's good for a parent or grandparent is good for the entire family. To the extent the senior can save money in mortgage costs, the bigger the ultimate estate that will pass to the family.
  • The ability to tap into more equity in the home can mean that family members who are providing assistance can either relieve the burden by hiring more paid caregivers or be paid themselves for providing care.
  • While current interest rates are very low, the rates set by the IRS are higher than money markets and certificates of deposit are paying these days.  This means that the family member or members advancing the funds will earn a bit more than they would if the money were sitting in the bank.
  • The private reverse mortgage can help protect the equity in the home since it takes precedence over any claim by MassHealth.

Some Caveats   

Family members who participate in private reverse mortgages need to be comfortable with giving up access to the funds the advance for a long period of time. It will only add to family stress if the family member or members extending the loan need the funds and put pressure on their parent or grandparent to sell the house or find other financing.   

In addition, there could be some risk for the family members loaning money. The ultimate proceeds of the sale of the house may be insufficient to pay back the entire amount loaned plus interest.  And typically, in private transactions no one obtains title insurance, meaning that the lenders may be at risk if title problems arise.     

In short, all family members should go into a reverse mortgage transaction (or any intrafamily financial arrangement, for that matter) with their eyes open.

Conclusion

The family of any senior who owns a home but who has little in savings should consider the private reverse mortgage as a way to help parents and grandparents have the retirement they deserve.  However, where no family members or friends can extend a private loan, a commercial reverse mortgage may be the best and only option for a senior homeowner to obtain the resources necessary to continue to live at home and get whatever care he or she may need.

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