If you take out a reverse mortgage, you can leave your home to your heirs when you die, but you'll leave less of an asset to them. Your heirs will also need to deal with repaying the reverse mortgage, and they could face major problems in the process, otherwise the lender will foreclose.
Once you learn more about this kind of loan, and the kind of issues your heirs might face if they want to keep the property, you might think twice about getting one.
A "reverse" mortgage is a particular type of loan in which older homeowners convert some of the equity in their home into cash. The cash is generally distributed in the form of a lump sum (subject to some limitations), monthly amounts, or a line of credit. You can also get a combination of monthly installments and a line of credit. The most popular type of reverse mortgage is FHA's Home Equity Conversion Mortgage (HECM).
This kind of loan is different from regular “forward” mortgages because with a reverse mortgage, the lender makes payments to the homeowner, rather than the homeowner making payments to the lender. Because the homeowner receives payments from the lender, the homeowner’s equity in the property decreases over time as the loan balance gets larger.
Generally, in order to get a reverse mortgage a borrower must be at least 62 years of age, occupy the property as his or her principal residence, and have substantial equity in the property (or own the home outright).
With a HECM, the loan has to be repaid when one of the following events occurs:
When a person with a reverse mortgage dies, the heirs can inherit the house. But they won’t receive title to the property free and clear because the property is subject to the reverse mortgage.
So, say the homeowner dies after receiving $150,000 of reverse mortgage funds. This means the heirs inherit the home subject to the $150,000 debt, plus any fees and interest that has accrued and will continue to accrue until the debt is paid off.
Under a HECM, those who inherit a home that's subject to a reverse mortgage get four options.
1. Pay back the loan. (With a HECM, the heirs can choose to repay 95% of the appraised value themselves and keep the home. FHA insurance will cover the remaining loan balance.)
2. Sell the home and use the proceeds to repay the reverse mortgage. (With a HECM, the heirs can sell the home for the full amount of debt owed on the loan or an amount that is at least 95% of the current appraised value of the property.)
3. Deed the home to the lender.
4. Do nothing and let the lender foreclose.
According to a USA Today article from December 2019, heirs who want to pay off a reverse mortgage and keep the home often face months of red tape and frustration when dealing with the loan servicer. Shoddy loan servicing practices often hinder what should be routine paperwork, debt calculations, and communications with borrowers or heirs.
As the article notes, the daughter of one reverse-mortgage borrower sent in a form indicating she wanted to purchase the property and got approved for traditional financing, but still received a notice of default (the first step in a California nonjudicial foreclosure). The servicer also designated the home as vacant and turned off the water in the name of property preservation, and scheduled a foreclosure sale. This situation is not uncommon.
The U.S. Department of Housing and Urban Development (HUD), the regulator of HECMs, has guidelines that say servicers of these loans should inform survivors and heirs of their options and resolve the loan within six months of a death. So, generally, under the guidelines, heirs should have six months to satisfy the debt. If they're selling the property and it's still on the market after six months, or they're still actively seeking financing, heirs can contact the servicer and request a 90-day extension, subject to approval by HUD. One more 90-day extension can be requested, again with HUD's approval. But that guidelines don't prevent the servicer from pursuing a foreclosure during this time. In fact, HUD’s policies require servicers to initiate foreclosure within six months of a default.
While you face delays or roadblocks due to an issue with the property's title, an impending foreclosure, or a lack of information from the servicer, you'll have to pay for the home's upkeep, taxes, and insurance, and interest and fees will continue to accrue on the debt while you try to work out any of the above options. Also, heirs have noted that servicers often won't negotiate and don't communicate during the workout process, and homes end up being foreclosed in many cases.
Reverse mortgages are complicated and are often not the best option for older homeowners seeking access to extra cash. Before taking out a reverse mortgage and tapping into your home equity, you should be sure to explore all of the options available to you. For instance, you might qualify for a state or local program to lower your bills or you could consider downsizing to a more affordable home.
You can learn more about reverse mortgages, as well as other available options for older homeowners, at AARP’s website at www.aarp.org/revmort. Even though you'll have to complete a counseling session with an HUD-approved counselor if you want to get a HECM, it's also highly recommended that you consider talking to a financial planner, an estate planning attorney, or a consumer protection lawyer before taking out this kind of loan.