Reverse mortgages may help older adults stay in their homes if they have equity but not a lot of savings. But what happens when the money from a reverse mortgage runs out?
Imagine Veronica. She is worried about her mother’s financial situation, and is considering doing something that may impact her own financial future to help.
At 65, she is preparing for retirement and is considering tapping into her own 401(k) to pay back the reverse mortgage. Veronica’s mother’s home is worth $1.5 million and the reverse mortgage was for $500,000, but now the money has run out.
With $800,000 in her 401(k), Veronica plans to take $250,000 out of it to put toward paying off the reverse mortgage, and using some of her cash savings to cover the rest. She’s unsure of the rules around taking withdrawals on her 401(k), and what the tax implications will be.
She is also wondering if she can pay off the reverse mortgage, and then perhaps take out a new mortgage on her mother’s house, in her own name.
She thinks that maybe she would get tax deductions on the interest payments on a new mortgage that could benefit her tax situation when she starts taking required minimum distributions from her 401(k). But is she correct?
Older adults who have a lot of equity in their homes but not a lot of savings to live on often choose a reverse mortgage so that they can stay in their homes, and have a steady income besides. However, a reverse mortgage is not without its downsides.
For example, the Federal Trade Commission (FTC) warns that taking a reverse mortgage can limit your options in the future. It warns that you could use up the equity in your home; if you wanted to move to a smaller home, or into assisted living, you may not have the money to do so. (1)
People who are 62 and older can qualify for reverse mortgages. The amount that you qualify for is based on the equity you have in your home.
When you take out a reverse mortgage, you are increasing your debt: not only do you pay fees on the reverse mortgage, but interest as well, which accrues over the term of the loan. With a regular mortgage you are increasing your equity as you pay it down. With a reverse mortgage, it’s the opposite.
Typically, the reverse mortgage is paid back to the lender when you sell the house, or when you die. There may also be stipulations in the reverse mortgage that you must live in the home as your primary residence.
The FTC also notes that you must still have enough money to pay for taxes, insurance, repairs, and homeowner association fees. According to AARP, if you do not adhere to the loan’s terms, which typically include maintaining the home as your primary residence, and staying current on property taxes, home insurance and home maintenance, you risk foreclosure. (2)
According to the FTC, “the money you get through the reverse mortgage is tax-free and won’t affect your Social Security or Medicare benefits.”
Some older adults may choose a reverse mortgage if they do not want to leave their neighborhood, and buying another, smaller property in the same area would mean using a large portion of the proceeds from selling their existing home. This can be especially true in high cost of living areas.
Since Veronica is older than 59 ½ years old, she would not face the 10% early withdrawal penalty for taking funds out of her 401(k). (3) When she reaches age 73, she will be required to start withdrawing required minimum distributions (RMDs) from her 401(k), unless she continues working.
She will have to pay taxes on the withdrawals she makes, however. Since she is planning on making a large withdrawal to help her mother, and because she is still working, she should consider speaking to a tax professional about how much this withdrawal would be likely to cost her. She could also have to pay taxes on her Social Security benefits, if her income is pushed higher due to the withdrawal.
She should also strongly consider speaking to a financial planner, with the first order of business being her own retirement plan, and making sure she has a solid plan for her future.
Once she is certain that her own finances are in order, then Veronica can consider the best way to help her mother. The big considerations here are, first and foremost, finding a sustainable way for her mother to live. This may involve hard decisions, like selling the family home.
Veronica’s complicated plan to pay back her mother’s reverse mortgage, and then potentially take out another mortgage on her mother’s house in her own name, could cause a financial mess.
Since Veronica has siblings, who are also intended to be heirs when their mother dies, Veronica should seriously consider the impacts on mother’s estate from putting a large amount of her own money into her mother’s main asset.
Veronica and her mother should consider speaking with an estate attorney about the implications this decision would have. They should find out whether it would be possible for Veronica to be paid back from the estate when her mother passes.
Veronica also needs to check the loan agreement to make sure there are no fees or conditions for paying back the loan.
Reverse mortgages can be desirable options for older adults who do not have enough retirement savings to live on.
However, as Veronica’s mother’s situation makes clear, there are risks to reverse mortgages, including running out of equity, having fewer options if you want to move later, or leaving a financial quagmire for your heirs.
