Reverse mortgages get a makeover
If you are considering a reverse mortgage, there are significant new federal regulations you need to be aware of.
Reverse mortgages have been around for quite a few years. Many first took notice of them as a means of covering medical costs without having to sacrifice their homes. But reverse mortgages -- available only to those 62 and older -- have grown into something more, with some homeowners using them to supplement their retirement savings.
With that growth has come attention -- namely from the federal government. This past September, the U.S. Department of Housing and Urban Development announced major changes to the most common type of reverse mortgage, the Home Equity Conversion Mortgage.
Payments for equity
A reverse mortgage is an arrangement under which a lender makes payments to you for your home's equity, and the proceeds are generally tax-free. The loan doesn't come due until you sell the home (at which time you may be able to deduct the interest on your tax return) or die.
Generally, the lender can't sell the home; you retain ownership. If your estate or your family doesn't have the liquidity to pay off the reverse mortgage after your death, however, your estate might have to sell the home, and the estate would keep any proceeds in excess of what is owed to the bank.
The reverse mortgage market has been expanding over recent years. To stay competitive, many bigger mortgage lenders and banks began offering reverse mortgage products, some lowering fees and allowing more substantial payouts. A number of lenders even offer so-called "Jumbo" reverse mortgages for more highly valued homes. But HECMs, which are reverse mortgages created by and regulated by HUD, remain the most widely used.
HUD's sweeping changes to reverse mortgages were done largely in response to who is using reverse mortgages and to the expanding reasons why people are engaging in these arrangements.
For example, many higher-net worth individuals have been using reverse mortgages to fund vacations or buy recreational vehicles. Some have even been using them to fund the purchase of a second home. In turn, such usage has heightened the risks of default.
The HUD changes consolidate the two previously established loan types (standard and saver) into one loan type, with fees that vary depending on how much you borrow. Speaking of which, those fees have gone up. Also, there are now stricter limits on the size of larger loans, and borrowers won't be able to gain access to more than 60 percent of the total loan in the first 12 months. (This is a brief summary of the changes. Ask your financial adviser for the full details.)
New rules aside, don't overlook the estate planning potential of these arrangements. With a reverse mortgage, you could withdraw some equity from your home. You could then use the money to make annual exclusion gifts to your children or grandchildren, thereby reducing the value of your taxable estate. Under the annual exclusion, you can give up to $14,000 per year per recipient free of gift taxes ($28,000 if splitting the gifts with your spouse) without using up any of your lifetime gift and estate tax exemption.
Or you could use the money to fund 529 college savings plans for your grandchildren. 529 plan contributions qualify for the annual exclusion, and a special break only for 529 plans allows you to make five years' worth of annual exclusion gifts to a 529 plan in a single year. 529 plan assets can grow tax-deferred, and distributions used to pay qualified education expenses are income tax free.
The shaky housing market in many areas may have put a dent into the viability of reverse mortgages. But with the market's recent rebound, nationally speaking, these arrangements are likely set up for a comeback.
This has been a general discussion and is not intended to be advice to anyone. Be sure to discuss all the risks and rules with your financial adviser before signing on the dotted line.
Norm Grill is a certified public accountant and managing partner of Grill & Partners LLC, accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien. His " Money Matters" column appears monthly. He can be reached at n.grill@GRILL1.com.