Reverse mortgages potentially alter estate plans to an extent that your current plans are changed irreparably. If you choose to take on a reverse mortgage, you need to consider its effects on the objectives that you want to achieve with your estate plan and make adjustments to it in order to meet those objectives to the extent possible under the circumstances.
Brief Review of the Concept of a Reverse Mortgage
The reverse mortgage is a complicated subject. However, a rather basic definition of what it is and review of why it can be useful will be sufficient here since we’re focusing on how reverse mortgages can impact an estate plan.
Reverse mortgages can be useful because people too often head into their retirement years without sufficient funds to survive, let alone thrive. With the passage of time, the ability to pay for necessities can dwindle as assets are exhausted without many options for replacing them. Meanwhile, a person may own a house which can be their most valuable asset. By obtaining a reverse mortgage, a homeowner often is looking to use this as a source of available funds to pay bills.
Not every homeowner is eligible to pursue a reverse mortgage when cash outflows eat away retirement savings. In general, most reverse mortgages require that the borrower must be at least 62 years old to qualify and needs a sizable amount of equity in the home to be eligible. If a reverse mortgage is obtained, then the individual can withdraw amounts from the loan to be used according to the loan’s terms. Interest accrues on the withdrawals. Repayment on the loan must be made after the last borrower named in the reverse mortgage has permanently left the residence. If this does not occur, the lender will foreclose on the property.
How Reverse Mortgages Can Impact Estate Plans
While amounts received from a reverse mortgage can help a person to survive financially during old age, this can undermine a prior estate plan and will have implications when the estate plan is revised, as it should be, to deal with the effects from a reverse mortgage.
Because any amount received from the reverse-mortgage loan that has not been repaid prior to death becomes a debt of the estate, the house may be lost as an asset of the estate if provisions are not made for payment by the estate or by whoever would receive the house according to the estate plan.
The Effect on an Estate Plan Can Depend on Who’d Receive the House
With a reverse mortgage, the implications of this debt can change depending on who would receive the house via the estate plan. Broadly speaking, spouses are treated differently than non-spouses. However, there also are subcategories within the two broad categories so the estate planner must be careful to make allowances for all of these differences.
When a decedent’s estate plan names a non-spouse as the recipient of the home, the plan must account for the fact that the non-spouse cannot take over the reverse mortgage. Instead, there will be a limited amount of time to repay the loan if the house is to pass according to the estate plan. If the person (or the estate) is not in a position to quickly arrange for the repayment, this will result in a potentially important objective of the estate plan being unmet. When a reverse mortgage is involved, there are three main outcomes to consider during the preparation of an estate plan.
Three Possible Scenarios Involving Non-Spouses
These possibilities are paying off the amount owed when the reverse mortgage becomes due; selling the residence to raise the funds on the loan; and offering the lender a deed in lieu of foreclosure when a sale wouldn’t generate the amount of the mortgage debt.
Non-Spouse (or Estate) Can Pay the Amount Owed
First, someone who wants to keep the house and has (or can quickly raise) sufficient funds to pay off the outstanding debt from the reverse mortgage can make the payment and keep the property. When developing the estate plan, a person needs to have an idea regarding who might want the property.
The more difficult challenge is choosing someone who not only would want the house but also will be in a position for the reverse mortgage to be repaid when the time comes to do so. Repayment could occur when the recipient can arrange for a regular mortgage to pay the reverse-mortgage balance or has sufficient funds to pay the amount outright, or when estate funds are available to cover the debt.
Changes in circumstances occur throughout life so the estate plan may need to be revisited to maximize the possibility of everything falling into place with this objective. Even with careful planning, this outcome may fail.
Selling the Property to Raise the Funds is Option #2
The second scenario involves a non-spouse who either lacks access to funds to pay off the reverse-mortgage loan or simply decides not to keep the house. A sale could be pursued to attempt to generate enough money to pay off the balance owed on the reverse mortgage (as well as costs related to selling the property). The seller would be able to keep the amount above these debts, if any. On the other hand, with a reverse-mortgage balance that exceeds the property’s value, the estate or the beneficiary named in the estate plan will not owe the debt after the sale.
This scenario can be problematic because reverse mortgages often have due-on-transfer clauses. Federal law protects some inheritance situations from triggering these, most notably when spouses are involved. The estate plan needs to account for the laws and regulations that apply to a given scenario.
If the clause is triggered, then a sale needs to occur quickly, with the proceeds used to pay down the amount owed on the reverse mortgage. The time frame for the would-be beneficiary is six months plus two possible extensions. If the lesser of the entire reverse-mortgage balance or 95 percent of the property’s fair market value is unlikely to be obtained, then foreclosure is more realistic.
Finally, a Non-Spouse Could Offer a Deed in Lieu of Foreclosure to the Lender
However, there is a third option that a non-spouse might pursue in this situation to avoid the foreclosure process. The lender could be approached with an offer of a deed in lieu of foreclosure. The lender would not face the costs from a foreclosure while the owner of the property tied to the reverse mortgage surrenders property and bears no responsibility for the remaining debt.
If the estate does not – or cannot – provide for the funds to payment of the debt owed on the reverse mortgage, a person’s objective regarding the disposition of the house according to the estate plan easily can be thwarted. Since a person obtains a reverse mortgage due to the lack of available funds, the estate is unlikely to be in this position.
When Repayment of Reverse Mortgage is Triggered
The threat of foreclosure is realistic and can arise quickly upon the occurrence of a triggering event that renders the loan due. The notice is triggered when the final borrower on the reverse mortgage leaves the home permanently. A beneficiary named in the estate plan will have 30 days to answer the lender after receiving a “due and payable” notice. There is time pressure to choose a course of action regarding the decision to buy, sell, or return the property. Unless the estate plan is well planned and implemented effectively, this time frame could make a deed in lieu in foreclosure the most likely outcome, which would undermine the objective of the estate plan.
How the Situations Can Change When a Spouse Would Receive the Property
While having a non-spouse as the beneficiary of the gift of the house probably will not work out as planned, an estate plan that has a spouse inheriting the house is more feasible. Again, there are three general situations to consider. Furthermore, these are easier to anticipate when planning after the reverse mortgage is in place.
When There is a “Co-Borrowing” Spouse
With spouses, the outcomes involved in estate planning are based on the category in which the surviving spouse falls. The circumstances existing when the reverse mortgage was obtained dictate how a revised estate plan would be set up. First, there is the “co-borrowing” spouse who met the criteria to be included in the original loan documents. As with anyone who qualifies as a co-borrower on a reverse mortgage, the spouse can remain in the home and continued to draw available funds from the loan. The house – and the reverse mortgage – would eventually become part of the spouse’s estate, unless the debt was repaid before it became due and payable as previously explained. The co-borrowing spouse needs to deal with the house and the possible reverse-mortgage debt in her or his estate plan, as a result.
When There is an “Eligible Non-Borrowing” Spouse
The next category consists of the “eligible non-borrowing” spouse, who often does not meet the age requirement (62 years of age or older) at the time that the predeceasing spouse obtained the reverse mortgage. As long as the loan documents list the spouse as eligible but non-qualifying, this spouse can remain in the home but cannot receive funds from the existing reverse mortgage. Then, when the surviving spouse dies, the house and any remaining debt on the reverse mortgage become part of that spouse’s estate. Essentially, the first two categories work to postpone the difficulties of estate planning when a reverse mortgage exists.
When There is an “Ineligible Non-Borrowing” Spouse
The final spousal category involves spouses who did not meet any of the criteria from the other categories – these are “ineligible non-borrowing” spouses. The survivor has no right to stay in the house after the death of the first spouse unless the former pays of the amount owed on the reverse mortgage to buy the home. Otherwise, selling the home and providing the lender with a deed in lieu of foreclosure are the remaining options. In all three categories, the spouse who originally obtained the loan can include the house in an estate plan, but options ultimately are limited by the terms of the reverse mortgage.
When a Spouse Is Treated as a Non-Spouse
A surviving spouse generally is subject to preferential treatment in an estate that contains a principal residence that is subject to a reverse mortgage. However, in one situation, the spouse’s rights are no better than those of a non-spouse. A non-borrowing spouse receives protections as long as she or he was living with the residence with the borrowing spouse when the reverse mortgage was sign. If the estate plan seeks to pass the property to the surviving spouse, this person also would have to be living there after the other spouse dies. The latter requirement is consistent for all spouses, but the requirement that both spouses were living together from the reverse mortgage’s inception is not met. This leaves the survivor in the same position as a non-spouse who would be a beneficiary under the estate plan.
Necessary Mechanism to Implement Estate Plan Due to Reverse Mortgage
Beyond preparing a realistic estate plan for a house tied to a reverse mortgage, the borrower has to be aware of logistical problems that can further complicate the estate plan’s success. Financial privacy laws present a major obstacle because the lending institution cannot communicate with anyone who is not listed on the loan. To navigate this difficulty, the borrower must contact the lender and discuss who is named in the estate plan to handle the estate’s affairs. The institution will require written authorization from the borrower that permits the estate’s personal representative to take necessary action regarding the property and the reverse mortgage. This is essential to make the transition has smooth and efficient as possible.
Remember that, when the last borrower on a reverse mortgage has died, coordinated action is required to carry out the dictates regarding a house that are found in an estate plan. Circumstances may prevent the decedent’s wishes from being realized, but the plan’s directions must be followed by the estate’s personal representative. This person has to contact the named beneficiary and quickly ascertain if the beneficiary wants to buy, sell, or turn over to the lending institution the house subject to a reverse-mortgage debt and then make arrangements with all concerned parties to implement this decision because any outstanding debt continues to accrue interest, which can make a difficult situation even worse. In the final analysis, reverse mortgages are best avoided unless necessary funds during one’s retirement years cannot be obtained by other means.