Published April 12, 2011
Getting cash out of your home through a reverse mortgage is costly, even with the Federal Housing Administration's new reduced-fee Home Equity Conversion Mortgage, or HECM, Saver plan. For some retirees, the solution is turning to a family member instead of a financial institution.
Adult children or other willing family members with sufficient means can finance a private reverse mortgage. With the loan secured by a deed of trust, the cash can be paid in a lump sum, a line of credit or monthly installments, just like a reverse mortgage from a commercial lender. The loan must be documented and filed with the Registry of Deeds. A certified public accountant or an estate planning attorney can handle the paperwork.
Some financial advisers and estate planners regard the conventional reverse mortgage as a choice to be considered only when there is no viable alternative.
"I've been telling people for years that the reverse mortgage is the absolute last resort," says Benny Kass, an attorney in Washington, D.C. "If you can't refinance on your own when rates are low, or if you don't have family or friends that can help you out -- and you don't want to lose the house by way of foreclosure -- the reverse mortgage is an option."
Intrafamily loans have several advantages over conventional reverse mortgages, according to a December 2010 report by Consumers Union, California Advocates for Nursing Home Reform and the Council on Aging Silicon Valley. The upfront costs are much lower, for one thing, while the amount of equity homeowners can pass on to their heirs is higher.
Information from the National Reverse Mortgage Lenders Association provides a glimpse of how expensive regular reverse mortgages can be. You'll pay a loan origination fee that typically equals 2 percent of the first $200,000 of the home's value and 1 percent of the remaining balance, with the total capped at $6,000. Add another 2 percent of the home's value for the initial mortgage insurance premium, plus $1,000 or more for an additional laundry list of costs that include appraisal fees and title insurance. While getting an appraisal is also advisable with a private reverse mortgage, and you may decide to hire an attorney to handle the paperwork, you can avoid most of the other costs associated with a conventional reverse mortgage.
Keeping the loan in the family can make tapping into the home's equity more affordable, but too much of a bargain might make the family member-lender susceptible to the gift tax. To steer clear, make sure the interest rate at least matches the applicable federal interest rate, or AFR. The Internal Revenue Service updates applicable federal rates on its website monthly.
"Let's say the kids lend the parents $100,000," says Kass, who noted that the applicable federal rates in April 2011 were 2.49 percent for midterm loans and 4.25 percent for long-term loans. "Let's say you're going to do 3 percent. The monthly payment is $250. If the parents don't have that $250 a month, the kids, if they want, can give them a gift of up to $13,000 per person (without incurring any gift tax liability). The interest-only payment is $3,000 a year, which is way lower than the $13,000."
Kass adds that the midterm rate would apply if you are only lending the money for a couple of years; otherwise, you should use the long-term rate as your guide.
The Consumers Union report suggests using a spreadsheet to keep track of each family member's investment in the loan and the interest due.
A private reverse mortgage may not work for everyone. The Consumers Union advises that the family first needs to assess how much money the homeowner needs and whether the potential family lenders can afford to provide it.
As one financial adviser points out, an intrafamily loan may not be feasible when all the numbers are crunched.
"Sometimes the kids can't afford to provide the mortgage to the parents," says Debra Neiman of Neiman & Associates Financial Services LLC in Arlington, Mass. "They have too many obligations of their own, and they don't have the capital to provide the funding."
When you finance a reverse mortgage for a parent, you're purchasing a majority stake in the home, Neiman says. For that reason, you may want to evaluate how much the property will be worth. The type of dwelling, its appraised value, its location and the health of the local real estate market all factor in.
"If the child is going to do this, it's an investment on their part," Neiman says. "They are going to end up owning a property. They are taking an equity stake in the property now, and when the parent passes on, they'll have the remainder of the equity."
Because business transactions within the family can be sticky, communicating with other family members about the plans for the home when the parent dies or is no longer able to live in it is also important. If the lending family member later wants to sell the property, but other siblings or a surviving spouse who holds the remaining interest in the home object, there may be friction, Neiman says.
But as long as a private reverse mortgage won't disrupt peace in the family, it may be just the right choice for seniors seeking peace of mind through affordable retirement living.