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Reverse Mortgage Presents Retirement Planning Opportunities

A reverse mortgage is becoming an increasingly popular way to supplement retirement cash flow.  However, like most investment products, there are risks that must be considered.  A reverse mortgage can provide an eligible homeowner a guaranteed payment each month, or provide access to the equity in one's home, generally tax-free.  While there are different types of reverse mortgages available in the marketplace, this article focuses on the most popular form-a Home Equity Conversion Mortgage (HECM), which is backed by the U.S. Department of Housing and Urban Development.

Who is Eligible?
Federal law provides that only certain individuals are eligible for a reverse mortgage.  Generally speaking, in order to be eligible, the individual must: 1) be 62 years of age or older; 2) continue to occupy the home as his or her principal residence; and 3) meet with a counselor prior to taking out the reverse mortgage.  The amount the individual is eligible to borrow is based on his or her age and the equity value of the home. 

Homes Eligible for Reverse Mortgages
Reverse mortgages are governed by the same Federal Housing Administration (FHA) regulations that apply to traditional mortgages; therefore, a reverse mortgage can be obtained on most single-family homes, condominiums, planned unit developments and some types of manufactured housing.  Most reverse mortgages are made on a non-recourse basis, meaning your estate may not have to pay more on the reverse mortgage than the value of the home.

Types of HECMs
HECMs are offered in four variations:

1) A "Term" that provides the individual with a guaranteed stream of payments over a fixed period of time.

2) A "Tenure" that provides the individual with a guaranteed stream of payments over his or her life expectancy or until he or she no longer occupies the home as a primary residence.

3) A "Line of Credit" that allows the individual to draw against the line up to a set dollar amount.

4) A combination of a stream of payments and line of credit. 

Costs Associated with a Reverse Mortgage
The initial closing costs associated with a reverse mortgage are similar to those of obtaining a traditional mortgage.  After the loan closing, a reverse mortgage is drastically different from a traditional loan.  While a reverse mortgage can accrue interest at either a fixed or variable interest rate, no payments are due to the lender until the homeowner dies, or the homeowner no longer uses the mortgaged property as his or her primary residence.  Upon the occurrence of one of the foregoing events, the entire outstanding balance on the loan becomes due.  Because the reverse mortgage encumbers the property, it likely will result in little to no equity to pass on to heirs.

Other Conditions
A reverse mortgage does not cause a transfer of title to the home.  Therefore, the individual is still responsible for maintaining the home, providing insurance on the property, and paying property taxes.  Like all mortgages, if the homeowner fails to pay the property taxes or maintain property insurance, then the lender can foreclose on the reverse mortgage.  The interest accrued on a reverse mortgage is not deductible on the individual's tax return. 

Governmental Benefits Planning
If structured properly,, the proceeds from a reverse mortgage will not affect any governmental benefits the homeowner is receiving.  Pennsylvania does not treat reverse annuity mortgages as income for Medicaid and SSI eligibility purposes (unlike some other states).  However, any portion of monthly payments not spent as received, may be considered an available resource for these purposes.  Thus, proper planning must be done to ensure that the homeowner's governmental benefits will not be reduced.

Conclusion
A reverse mortgage can be a great retirement planning tool, but they are not without several potential pitfalls.  While a reverse mortgage can provide the extra cash flow needed in retirement, they may not be right for everyone.  Careful consideration should be given to the income and estate planning consequences before entering into such an arrangement.