Is It for You?
Ethan R. Okura
Hawai‘i Herald Columnist
A client recently asked me whether or not it’s a good idea to get a reverse mortgage. Before I answer that question, let me explain how a reverse mortgage differs from a regular mortgage.
Most of us understand what a regular mortgage is. You borrow money from a bank and sign a mortgage document, which gives the bank the right to sell your home in a foreclosure sale if you fail to make the payments.
Each month you make a payment to the bank. The payment includes interest. You make payments for a set number of years, usually 15 or 30 years. When you finish making all of your payments, the bank releases its mortgage. You own the home free and clear again.
A reverse mortgage is different. You borrow money from a bank. You can choose to borrow a lump sum all at once, or you can have the bank send you a set amount of money every month. (Every payment the bank sends you is a loan on which interest is charged.) Another option is to have a credit line, like a home equity mortgage, which allows you to decide when and how much money you draw, up to the amount of your approved credit. With a reverse mortgage, you do not have to make any payment to the bank until you die, sell your home or move out of your home. The bank charges you interest, usually at an adjustable interest rate. You have to pay your own real property taxes and homeowner’s insurance premiums. To get a reverse mortgage, you have to be 62 years of age or older. You can qualify for a reverse mortgage even if you have very little or no income. The amount you can borrow depends on your age, the interest rate and the value of your home. The older you are, the lower the interest rate; and the more valuable your home, the more you can borrow.
There are free websites with reverse mortgage calculators. This one at ReverseMortgageReviews.org (reversemortgagereviews.org/reverse-mortgage-calculator) shows how much you can borrow based on your age and home value. For example, if you are 65 years old and live in Honolulu with a home worth $800,000, you can borrow a lump sum of about $206,000, up front, and borrow another $154,000 twelve months later, for a total of about $360,000. There is another calculator at MortgageCalculator.org (mortgagecalculator.org/calcs/reverse-mortgage.php), which shows how much you will owe over time by taking a reverse mortgage.
With a reverse mortgage, the bank charges you interest on the money you borrow, just as it does with a regular mortgage. However, you do not make any payments while living in the home. Therefore, every month that goes by, the amount of interest you owe the bank is piling up more and more. For example, suppose you borrow $200,000 on a reverse mortgage. Assume that the interest rate is 6% a year. At the end of one year, you would owe the bank $212,000. It will actually be slightly more than that because the bank will charge you interest every month and add it to the amount owed, so you will pay interest not just on the amount you borrowed, but you will also pay interest on the interest that you are not paying each month.
At the end of 20 years, you will owe the bank $662,041. If you die at that time, the house will be sold and the bank will receive its $662,041. Any money left over from the sale, goes to the persons named in your will or trust. (Actually, there would also be fees which would be added to the amount you owe.)
Should you get a reverse mortgage? If you need cash, and you don’t care about leaving an inheritance to anyone, then a reverse mortgage may be right for you. However, if you want to leave an inheritance to your children or other loved ones, then a reverse mortgage may not be a good idea. With a reverse mortgage, the interest owing to the bank builds up so much that there may be little or nothing left for your loved ones at the end. A reverse mortgage also makes it difficult to protect your home from nursing home costs.
Unlike a traditional mortgage where the interest rate is usually locked in for the entire loan period, a reverse mortgage usually has a “floating” or “variable” interest rate. That means the bank can raise the interest rate over time if interest rates generally are going up. So, you might start off with a 4.5% interest rate, but then a few years later, it’s possible the interest rate could be 6% or more. If interest rates go up like they did in the late 1970s and early 1980s, you could end up owing interest at over 16%! That’s what the interest rate was in 1981.
I have had two or three clients who, over the years, happily and successfully used a reverse mortgage to their advantage. On the other hand, every other client who had done a reverse mortgage without consulting an attorney first later regretted doing the reverse mortgage. Many of them paid off the reverse mortgage at a financial loss as soon as they understood all the details — sometimes they needed their children to help financially to pay it off. Often, they were talked into doing it for the purpose of having cash to pay for potential nursing home costs in the future. That’s almost never a good idea because they were paying interest on money that they didn’t need yet.
Most of my clients have family members, friends, loved ones or even a charity that they want to leave their assets to when they die. Those who don’t, might really benefit from a reverse mortgage. If you are considering a reverse mortgage, you may want to ask an estate planning specialist whether it makes sense in your particular situation.
© OKURA & ASSOCIATES, 2021
Honolulu Office (808) 593-8885
Hilo Office (808) 935-3344
Kauai Office (808) 241-7500
Ethan R. Okura received his JD from Columbia University in 2002. He specializes in Estate Planning to protect assets from nursing-home costs, probate, estate taxes and creditors.
This column is for general information only and is not tax or legal advice. The facts of your case may change the advice given. Do not rely on the information in this column without consulting an estate-planning specialist.