Leaving a Legacy on Your Terms: Reverse Mortgages and Inheritance Crossroads

During your golden years, you deserve golden opportunities. Unfortunately, financial realities can sometimes cast a shadow on your retirement dreams. Healthcare costs, rising living expenses, and dwindling retirement savings often mean living on a tighter budget than planned, leaving seniors with difficult choices.

Enter the reverse mortgage. What is a reverse mortgage? Well, it’s a financial tool that allows you to unlock some of the equity in your home to pay off your mortgage (if you have one), provide cash to supplement your income, repair/remodel your home and/or provide additional cash reserves.  And best of all, with a reverse mortgage you never have to make a mortgage payment or pay it off for the rest of your life as long as you live in your home as your primary residence. Sounds great, right? But before you consider taking on a reverse mortgage,  it’s important to understand its long-term impact, particularly on heirs and estate planning.

This article will shed light on the relationship between reverse mortgages and estate planning so you can weigh the pros and cons and make informed decisions for your golden years and beyond.

Who Owns the House in a Reverse Mortgage?

Contrary to popular belief, you retain ownership of your home even after taking out a reverse mortgage. You remain the legal owner on the title to the property, free to live in, maintain and make improvements to your property. The lender simply holds a “lien” on the home, meaning they have a legal claim to it ONLY in the case of a  loan default. As long as you live in your home, pay your property taxes and maintain the property, you can never be in “default” on a reverse mortgage.

However, it’s important to understand that the loan balance on your reverse mortgage will grow larger each month as the accumulated interest expense is added to the loan balance.  That’s why it’s called a “reverse” mortgage because the loan balance goes in the opposite direction of a traditional mortgage where the loan balance gets smaller each month as you make your mortgage payments. Remember, as long as you live in your home, you never have to make a mortgage payment or pay off the reverse mortgage balance.  You literally never pay a penny until the home is sold. Typically, you and your spouse (if you have one) live in the home the rest of your life; and when your heirs inherit the house, they sell it to pay off the reverse mortgage balance and split all the cash that is left over. So, while you enjoy financial freedom in your retirement, be aware that your heirs’ future inheritance is affected by a reverse mortgage.

The Estate Planning Puzzle: Fitting a Reverse Mortgage into the Picture

A reverse mortgage is a good estate planning tool.  In simple terms, you are effectively “spending” some of your heirs’ inheritance while you are living in your home because the reverse mortgage loan balance grows bigger each year. That means when your heirs inherit the house and sell it to pay off the reverse mortgage, they would get less money than if you did not have a reverse mortgage. But in almost every case, everyone is happy with that arrangement. The parents are happy enjoying financial freedom thanks to the reverse mortgage funds from the equity they have earned over the years, and the “kids” are happy their parents are living stress-free in their golden years.  In most cases, the “kids” don’t want to keep the house; and they don’t want or need much money from the eventual sale of the home. But there are some situations where inheritance is a factor to consider, and below are some points to keep in mind.

• Spousal Considerations: If your spouse is a co-borrower on the reverse mortgage, after you pass they can continue living in the home the rest of their life, never have to make a mortgage payment and if you have a  reverse mortgage line of credit, they can draw out any remaining funds available. However, if they choose to move out of the house, they would have to sell the house and pay off the reverse mortgage balance owed at that time.  They would keep all the cash received over the amount necessary to pay off the mortgage balance and cover the real estate selling costs.
• Inheritance Options for Non-Spouses: When non-spousal heirs inherit a property with a reverse mortgage, they have two  choices:
  • 1) Sell the home to pay off the reverse mortgage balance and keep the remaining cash sale proceeds.
  • 2)  Refinance the home with a new mortgage to pay off the reverse mortgage balance and retain ownership of the home.
• Tax Implications: While the proceeds from selling a home inherited with a reverse mortgage are generally not considered taxable income for their heirs, it’s crucial to consult a tax professional to understand the specific implications in your case. (It’s also worth noting that reverse mortgage funds drawn out of the home by reverse mortgage borrowers aren’t considered taxable income.)
• Communication and Transparency: Open and honest communication with your heirs about your decision to utilize a reverse mortgage is paramount. You should tell them about the loan terms, potential impacts on their inheritance, and their options after your passing. This transparency lays the groundwork for smooth transitions and prepares them for the important financial decisions that must be made during a very emotional time.

Weighing the Scales: Advantages and Potential Drawbacks of Reverse Mortgages

There are undeniable advantages of taking out a reverse mortgage in your golden years, including:

• Enhanced Cash Flow: Accessing the equity in your home can supplement your retirement income, boost your financial security, and allow you to enjoy a more comfortable, financially stress-free lifestyle.
• Maintaining Independence: Remaining in your beloved home offers invaluable emotional and practical benefits. Reverse mortgages enable you to age in place, preserving your sense of familiarity and community. Often, that is even more important than financial considerations.
• No Monthly Mortgage Payments: Unlike traditional mortgages, reverse mortgages don’t require monthly payments, easing the cash flow burden during retirement with limited income.

However, it’s essential to acknowledge potential drawbacks as well, which include:

• Reduced Inheritance for Your Heirs: As mentioned above, the reverse mortgage loan balance grows as you live in your home,  reducing the amount of money your heirs will receive when they eventually inherit and sell the home in the future.
• Loan Fees and Origination Costs: Although you pay NO MONEY out of pocket when you close a reverse mortgage at Best Mortgage, reverse mortgages come with upfront government fees and origination costs that immediately add to the loan balance owed against your home. That’s why a reverse mortgage is primarily intended for seniors who plan to live in their home the rest of their lives, or at least for a very long time.
• Debt Accumulation: Remember, you never make monthly mortgage payments, so the loan balance keeps accruing interest and growing larger.  Of course, your home is likely to continue appreciating in value as well. So there will probably always be equity in your home, but it will be less than if you did not have a reverse mortgage on your home. That does not affect you if you live in the home the rest of your life and never sell.  But it will affect your heirs because they will have a bigger loan balance to pay off when they inherit the house and sell.

Finding the Right Fit: Making Informed Decisions with Guidance

Ultimately, the decision to utilize a reverse mortgage requires careful consideration. Weighing the benefits against the potential drawbacks in the context of your specific personal financial situation, retirement goals, and family dynamics is crucial. Consulting a trusted financial advisor and estate planning attorney is vital to ensure you make the right decision that caters to your unique needs and protects your loved ones’ future.

Here are some additional tips for navigating the reverse mortgage and estate planning crossroads:

• Explore Alternatives: Before committing to a reverse mortgage, investigate other options such as downsizing your home, tapping into retirement savings, or seeking employment opportunities for additional income.
• Set Realistic Expectations: Don’t view a reverse mortgage as a magic wand. The loan can enhance your retirement, but it’s not a guaranteed solution to all financial woes. At Best Mortgage, we will help you determine if a reverse mortgage is right for YOU, and more importantly, we will always tell you if a reverse mortgage is NOT right for you.
• Plan for Future Care: If you anticipate needing long-term care, consider the potential costs and how they might impact your reverse mortgage utilization.
• Review Loan Terms Carefully: Before signing on the dotted line, meticulously review the loan terms.  Seek clarification on any uncertainties before proceeding.

Remember: Your golden years should be a time of celebration and relaxation, not financial strife. By approaching reverse mortgages and estate planning with open eyes and seeking professional guidance, you can unlock additional financial freedom while laying the groundwork for a secure and fulfilling legacy for your loved ones.

A Word from Best Mortgage

At Best Mortgage, we understand the unique challenges and financial considerations seniors face in the Greater Seattle area and throughout Washington State. That’s why we’re committed to offering personalized advice and guidance, “Honest Advice You Can Trust”(r) helping you explore your options and make informed decisions about your personal financial future. Whether you’re considering a reverse mortgage or seeking other loan solutions, our experienced team is here to support you every step of the way.

Contact Best Mortgage today or call (425) 649-6000 for a free reverse mortgage consultation, and let us help you unlock the door to a more secure and fulfilling retirement.