Ethan R. Okura
Hawai‘i Herald Columnist
Last month, I explained the reverse mortgage. I advised that if you need money and if leaving an inheritance is not a concern, a reverse mortgage may be a good idea. However, if you want to leave an inheritance to your children or other loved ones, a reverse mortgage is probably not a good idea.
Suppose that a senior citizen needs money. She hears that she can receive money by getting a reverse mortgage, and does not have to pay any money back to the bank while she is living. Her home is worth $1,000,000. She signs up for a reverse mortgage and borrows $466,000, which she spends during her lifetime. She is told that after she dies, the reverse mortgage will have to be paid off, but her children will still inherit the equity in her home. (“Equity” is the difference between the value of the home and the mortgage you owe. For example, the equity in this woman’s home is $1,000,000 minus $466,000, or $534,000).
Let’s suppose the woman dies after 10 years. The bank then tells her children that if they want the home, they have to pay the bank all the money that their mother received from the bank, plus interest. Suppose the average interest rate for the reverse mortgage during the 10-year period was 6% per year. After 10 years, there is $381,839 of interest owed. Even though 6% of $466,000 equals only $27,960 of interest for one year, and you would think that 10 years should only add up to $279,600 of total interest, you have to add interest on the unpaid interest each year in addition to the interest on the original loan amount, so you actually end up owing more than 10 times 6% of the original loan amount.
When you add the loan amount plus the interest, the total amount owed when mother dies is $466,000 + $381,839, or $847,839. The children either cannot afford to pay the bank $847,839, or do not want to pay. The bank forecloses on the reverse mortgage. That means that the bank sells the property at an auction sale. No one else bids. (Properties are often sold at auction sales for much less than their fair market value.) Therefore, the bank becomes the owner of the property. All the money that the bank pays at the auction sale goes right back to the bank, to pay off the reverse mortgage loan, plus interest. Now the bank can make more profit by selling the property at a price higher that what it paid. Since the bank paid only the amount that was owed for the property under the reverse mortgage, there is no money remaining from the auction sale. The children inherit nothing, because their “equity” disappeared!
I have been told that there were a number of court cases in which children have sued the bank that ended up owning the family home because of a reverse mortgage. The children have lost these cases. Many of these cases were from the island of Kaua‘i. There must have been an aggressive reverse mortgage salesperson in Kaua‘i a few years ago.
If you are in serious need of money but want your children to inherit your property, try discussing your need with them. Could one of your children possibly loan you the money with a reverse mortgage owing to your child instead of the bank? In other words, one or more of your children could send you some money each month. You would owe that money to your child, with interest, but would not have to pay anything while you are living. Legal documents would be prepared for the loan.
After you pass away, the house could be sold at a fair price (perhaps to one of the children), instead of being forced to be sold for a low price in an auction sale. The money from the sale could be used to pay back the child or children who loaned the money, with interest, and the rest of the money (the “equity”) could be divided among all the children. This way, the child who loaned the money profits from the interest, and all the children inherit the equity rather than it going to the bank in an auction sale. This is just one idea. There may be other possibilities.
It’s always a good idea to consult with an estate planning attorney to understand the benefits, risks, tax consequences, and possible effects on future Long-Term Care Medicaid qualification for nursing home costs before you make any major decision regarding your home or other assets.
© OKURA & ASSOCIATES, 2021
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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.