March 9, 2017
Maybe your friend just booked a month-long cruise. Perhaps you want to help your favorite grandson pay for law school. Or, maybe you just want to eat out on University Avenue every day. If you have one or more of these intentions but limited monthly income and liquid savings, the question arises about how to accomplish your goals and still enjoy your retirement.
You may have seen Tom Selleck advertising reverse mortgages on a TV commercial, and you may have started to wonder if this could be right for you. In fact, reverse mortgages are loans for people over 62 years old and require no monthly payments. You have the option of accessing your home equity in several ways: by receiving a monthly check, having a credit line, taking a lump sum of cash at closing, or using a combination of all of these options. The mortgage balance increases each month by the amount of money withdrawn from the credit line, or the amount of the check— plus, of course, the interest. There are some safeguards in place as reverse mortgages are non-recourse loans, meaning the lender is not required to be paid any loan balance above the home value. While this type of loan may seem like an attractive way to unlock the equity in your home, there are multiple issues to consider when contemplating a reverse mortgage. Potential pitfalls arise if you anticipate moving into a retirement home or nursing facility, or want one of your heirs to retain the home after you pass away, or have a spouse who is significantly younger than yourself.
Reverse mortgages soon become due upon the sale of the home, when you pass away, or when the home is no longer your primary residence. This can be problematic if you move to a retirement or nursing home because your mortgage balance becomes due, even if you do not sell the home. It is also unlikely that you have accumulated enough funds to pay it off; if you had those funds, you would likely not have needed the reverse mortgage in the first place. In addition, there are often fairly significant moving costs for a retirement or nursing home, at the same time as the mortgage becomes due. Finally, retirement centers or nursing homes often have large monthly dues that cover food, activities, and other services, all of which you will not be able to pay for using the reverse mortgage since your monthly checks stop immediately.
While there are pros and cons for people around the country, reverse mortgages can be particularly dangerous for people owning highly appreciated Silicon Valley real estate. Generally, under federal and California law, the step-up in basis rules mean that capital gains tax is forgiven at the owner’s death, which creates an incentive for people to hold highly appreciated real estate until death. Unfortunately, most reverse mortgage contracts require the sale of the property within six months of the owner moving out, which means some seniors may have to recognize millions of dollars of capital gains that could otherwise go tax-free.
Since it is unlikely you will have sufficient funds to pay off the reverse mortgage at the time of the move, you will likely have to sell the home. This means you will have to pay a substantial amount of avoidable tax. These negative tax consequences could be quite costly and may defeat other estate-planning goals. One of these goals may be that one of your heirs continues to own the house after you pass away. Again, in this case the mortgage becomes due at that point. If your estate or heirs do not have enough cash to pay off the mortgage, they are forced to sell the home to do so.
A final consideration should be the financial well-being of a spouse who is significantly younger than yourself and is not on the title to the property. The rights of surviving spouses not on title to stay in the home are complicated and not always guaranteed. Reverse mortgages can be useful tools to allow you to enjoy your retirement years in comfort. However, they are not right for everyone. The long-term potential pitfalls associated with them should be carefully weighed against the short-term benefits of having more cash available to cruise the world, educate your descendants, or dine in style.
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