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Advisors that have older clients are apt to receive some questions about reverse mortgages, a product that is typically geared toward folks 62 years old and above.
Data from the U.S. Census Bureau indicate just 2 to 3 percent of eligible seniors pursue reverse mortgages, but that number could rise in the coming years as long-term care costs and life expectancies increase, meaning financial advisors are likely to have more reverse mortgage conversations with clients and their heirs.
The concept is usually simple: a homeowner that's 62 or older that either has considerable equity in the property or owns it free and clear may evaluate a reverse mortgage to unlock some or all of that equity. As mandated by federal regulations, a reverse mortgage loan cannot exceed 95 percent the value of the home. For example, a senior with no mortgage on a $500,000 house can get a reverse mortgage for $475,000 no more.
Reverse mortgages are typically made in lump sum payments, fixed monthly payments or as lines of credit, but the homeowner isn't on the the hook for a monthly payment as they were with a traditional forward mortgage.
“Instead, the entire loan balance becomes due and payable when the borrower dies, moves away permanently or sells the home,” according to Investopedia.
Know The Risks
As advisors, we're often programmed to believe we are fiduciaries of the capital clients give us. That's certainly true, but a big part of being an advisor is the actual business of advice and that means knowing when to steer a client clear of potential pitfalls. At the very least, it means knowing what the pitfalls are and initiating a conversation with a clients about those landmines.
Indeed, reverse mortgages carry risks that can outweigh the benefits for some clients. Consider the following: while reverse mortgages are being discussed in straight forward terms here, the loans themselves often feature layers of complexities that borrowers gloss over simply because they want the cash. They later find out it's extremely difficult to adjust the terms of the loan if their having problems repaying and refinancing is significantly harder than it is with a standard mortgage.
In fact, the Consumer Financial Protection Bureau (CFPB) has reported a rising number of complaints related to those issues in recent years.
“Borrowers also complain about not being able to add additional borrowers to the loan in order to avoid the loan balance becoming due,” according to Forbes. “For instance, adult children complain about not being able to be added to the loan as borrowers or at least to become eligible non-borrowers. As well, non-borrowing spouses have complained about not being able to be added as borrowers after the loan has commenced.”
Another risk clients may not be aware of, but advisors certainly should be, is that some government benefits may be affected by a clients decision to take a reverse mortgage. For instance, Medicaid benefits are set by the recipient's liquid assets. A reverse mortgage boosts that liquidity and can lead to reduced to Medicaid benefits.
No Free Lunch
One of the most important factors advisors need to address with clients mulling reverse mortgages is that the loan comes due when the borrower passes away. Inability to pay can lead to loss of the property and the surviving spouse (if there is one) being evicted from the property, among other unpleasant scenarios.
To those points, clients that have heirs should involve those beneficiaries in the reverse mortgage discussion with advisors. Moreover, advisors should, in the event the client is dead set on the liquidity aspect of a reverse mortgage, press the borrower to consider borrowing a sum that they need, not what they want so the future burden to beneficiaries is reduced.
For example, a client may want that 95 percent of their home equity, but perhaps they only need 20 percent or 30 percent. Lower repayment terms better position surviving families to keep the home in the family and out of the hands of the lender. Translation: if a reverse mortgage is the route a client decides to take, advisors should ensure the amount borrowed is something surviving family members can handle the repayment of to ensure continued ownership of the property.
Related: The New Generation Of Asset Allocation: It’s All About Life Planning