The nuts and bolts of reverse mortgages
Last week we provided an overview of how reverse mortgages work. This week, we cover the nuts and bolts — meaning what is actually contained within the mortgage documents.
So, you thought they would just give you the money because your home has equity collateral? No, there are numerous terms and conditions attached. I spent considerable time researching reverse mortgage products offered in the US market. One reverse mortgage sample contract is linked below, all 32 mind-numbing pages, but that is my job and my mission, to make it easier for you to figure out what, where, when, and how the contract you may be able to negotiate actually works. Currently, I am not aware of any reverse mortgage product offered in Bermuda.
My first caution is to never sign any contract without reading tediously through the entire missive. Everyone should always review very carefully any legal document.
For instance, how many of you ever looked at the contract issued with a credit card. Well, gee, it is only 16 pages long (or longer) full of financial terms, conditions, disclosures, and indemnities. My bet, one out of six readers have actually read the contract. Honest disclosure, I never looked at mine either — until years later.
Contracts are always very revealing. In civilised societies with decent laws for consumer protection, financial product providers must spell everything out, including how they compute interest charges, penalties, fees, admin costs, and related items.
You realise that if you run into problems with any contract you sign, you can not whine and complain when things go wrong because you never bothered to read the terms and conditions.
Readers, my statement is not intended to imply that you are not capable of handling your financial affairs. The truth is, if I phrased the question this way: “Do you hate reading legalese and financial documents?” Five out of six of us would say yes.
We return to our hypothetical couple, George and Rochelle, just so pleased because they have been able to obtain a reverse mortgage on their home in the amount of $300,000 (50 per cent of the appraised value). What they still do not realise is that the amount of the mortgage that will have to be repaid is far more than $300,000. No, they were actually awarded 66 per cent of the $600,000 value, reduced by interest, carrying charges, and administrative fees. This means the amount to be paid back at their demise is estimated at $402,000 and could be significantly higher, depending upon changes in variable interest rates.
What they also find bewildering is that their contract with the bank is actually two contracts: one to receive the funding from the bank, and the second, what appears to be a standard mortgage document promising to pay the money back (or their estate). See our sample contract has five different documents attached, drawn for various funding choices.
In general, these are the standard mortgage terms and conditions that must be adhered to; meaning a breach of any of these is a serious problem since the lending institution could force foreclosure.
• They keep title to deed.
• They have released equity in home for current expenses.
• They can stay in home for remainder of life.
• The homeowner has the right to change mind on contract within five days.
Furthermore, they can choose the method of payment, which can be one or any combination of those listed below.
• A lump sum of cash at closing.
• Equal monthly payments as long as the homeowner lives in the home.
• Equal monthly payments for a fixed period of months.
• Have a line of credit that can be drawn in any amount at any time until the line of credit is exhausted.
Homeowner’s obligations and restrictions
While homeowner is alive:
• Property must be maintained at current value. Property inspections will be done by the bank at intervals to ascertain same.
• Adequate property insurance carried at replacement value, including flood and hazard.
• Taxes on home must be paid and kept current.
• Homeowner (and any other party to the mortgage) must be resident and present in the home, so, no family members or other friends minding the place while homeowner takes an extended vacation.
• Any rental income produced by the property (say, letting rooms or attached studio) must be remitted to the bank.
• Property cannot be conveyed in life interest estate planning.
• Property cannot be conveyed into a trust as the trust is not considered an occupant of the home.
At the maturity event, the property is sold or relatives assume the debt and repay the bank meaning when the contract is fulfilled:
• All borrowers have passed away.
• All borrowers have sold or conveyed title of the property to a third party.
• The property is no longer the principal residence of at least one borrower for reasons other than death, say, when declining health dictates that the homeowners are moved to long-term nursing home care.**
In certain circumstances, the contract is breached and immediate payment is due because of the following:
• The borrower does not maintain the property as principal residence for a period exceeding 12 months because of physical or mental illness
• Borrower homeowner fails to pay property taxes and/or insurance and all attempts to rectify the situation have been exhausted
• The property is in disrepair and the homeowner has refused or cannot repair the property.
My opinion on other drawbacks are:
**Nursing home care intervention when removing a homeowner is a serious situation. The loan can be called at that time, leaving relatives or the bank no recourse but to sell the home to satisfy the debt. Loss of dignity and hope is all that remains for the ailing homeowner who can never go home again.
Granny sitting in the street. The reverse mortgage is written for a specified length of time, say 20 years. What happens if the homeowner is still inconveniently alive when the reverse mortgage payment is due? Then life-to-death planning becomes the ultimate morbid limbo.
Reverse mortgage lump sum and credit line payment options. I am adamantly opposed to these choices. Almost no one, regardless of who you are or where you came from, can appropriately manage a lump-sum payment to last 20 or more years. There is always some needy child, or relative out-of-work, a business looking for a loan, or a charity, working on your guilt. The money disappears in short order, leaving the homeowner penniless and with a massive debt load on the home. The worst of worst situations.
It may all be a moot point. Is any lending institution willing to offer a product that has a 20- to 30-year time frame before any profit is earned?
* Sample reverse mortgage loan documents
National Reverse Mortgage Lenders Association
Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Pondstraddler Life, financial perspectives for Bermuda islanders with multinational families and international connections on the Great Atlantic Pond. Contact: firstname.lastname@example.org
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