Private Reverse Mortgages

What is a reverse mortgage?  Similar to a conventional mortgage (“Conventional Mortgage”), the borrower in a reverse mortgage (“Reverse Mortgage”) will continue to own the home.  The lender does not take title to the home, but rather will have a lien on the property.  The term “reverse” is essentially referring to a chronological difference compared to a Conventional Mortgage.  In a Conventional Mortgage arrangement, the borrower receives loan proceeds, but then must make monthly payments in order to pay down the borrowed principal and accrued interest.  In contrast, in a Reverse Mortgage arrangement the borrower does receive the loan proceeds up front, but no payments on the loan need to be made while the homeowner is alive and continues to live in the home.  In a Reverse Mortgage, the loan is most commonly paid off following the death of the homeowner.

What is a private reverse mortgage?  A private reverse mortgage is simply a mortgage loan arrangement where a family member or other third-party individual serves as the lender, rather than a commercial financial lender.  Commercial reverse mortgage loans must comply with quite a few federal laws and regulations but private loan arrangements have no such regulatory requirements and therefore permit much more flexibility.

What are the advantages of a private reverse mortgage as compared to a commercial one?  Commercial reverse mortgage loans can be very expensive to the borrower and may include hefty loan origination fees that are effectively hidden, since the loan often is not repaid until after the borrower has passed away.   In contrast, the avoidance of expensive fees via a private mortgage provides a financial benefit to the borrower and/or other family members, since those commercial loan fees would otherwise erode the assets of the homeowner that may eventually be left for heirs to inherit.  Another common cost involved in a commercial arrangement is mortgage insurance that insures the lender against non-repayment.  Such mortgage insurance will not be required with a typical private loan arrangement.

What types of situations would merit a private reverse mortgage arrangement?  A private reverse mortgage is a mechanism that can provide a reasonably healthy but cash-poor senior homeowner with sufficient liquidity to stay in the home.    It can also provide a source of funds for the homeowner to employ home health aides, which may make it possible for the homeowner to stay at home safely for a longer period of time.  However, if from a care planning perspective the senior homeowner cannot be adequately cared for outside of a nursing home or an assisted living facility, then a private reverse mortgage would not be a suitable planning tool even if the family has the financial means to make it work.

One fairly basic requirement for a private loan is a lender with sufficient liquidity to make the loan.  From the perspective of the prospective lender, the reverse mortgage loan is an investment and the lender must be mindful of the opportunity cost of not making other sorts of investments with the sum borrowed by the homeowner.

What are potential issues or things to avoid in a private reverse mortgage arrangement?  To protect both the borrower and the intra-family lender, the arrangement must be formally documented.  A commercially viable promissory note and mortgage deed must be drafted and the signed mortgage deed must be recorded on the town land records just like any other deed.

To be considered commercially viable, the loan must accrue interest at a reasonable rate given the prevailing interest rates at the time the loan is made.  While the family member lender may not care much about earning interest on the principal of the loan, the IRS will impute an interest rate if none is set under the terms of the loan.  If the homeowner eventually applies for Medicaid or similar benefits the loan may be questioned if the interest rate is to high or otherwise not commercially reasonable.

Like any loan, the lender is assuming some risk that the loan will never be fully repaid in the end.  A reverse mortgage is repaid using the sale proceeds from the equity in the home after the homeowner dies.  If the fair market value of the real estate declines after the loan is made for any reason, then the proceeds may not be sufficient to repay the loan in its entirety.  If the family collectively agrees that one member of the family should make the loan, and there is an issue later where the loan cannot be fully repaid, intra-family acrimony may be heightened since not all of the homeowner’s children have borne the financial costs equally.

As with any significant financial decision, it is important to have knowledgeable counsel during the process of obtaining a private reverse mortgage.  If you have questions about this tool, or planning for long-term care at home, please call our office at 888-822-8778.

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