Reverse mortgages can help seniors stay in their homes if they have equity but not much savings. But what happens when the money on a reverse mortgage runs out?
Imagine Veronica. She is worried about her mother’s financial situation and is considering doing something that may affect her own financial future to help her.
At age 65, you’re preparing for retirement and considering tapping into your own 401(k) plan to pay off the reverse mortgage. Veronica’s mother’s house is worth $1.5 million and the reverse mortgage was $500,000, but now the money is gone.
With $800,000 in her 401(k), Veronica plans to take out $250,000 to pay off the reverse mortgage and use some of her cash savings to cover the rest. She’s unsure of the rules around withdrawals from her 401(k) and what the tax implications will be.
He also wonders if he will be able to pay off the reverse mortgage and then perhaps get a new mortgage on his mother’s house, in his own name.
She thinks she might get tax deductions on 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 he right?
Seniors who have a lot of equity in their homes but not much savings to live on often choose a reverse mortgage so they can stay in their homes and also have a stable income. However, a reverse mortgage is not without disadvantages.
For example, the Federal Trade Commission (FTC) warns that taking out a reverse mortgage may limit your options in the future. Warns that you could deplete the equity in your home; If you want to move to a smaller home or assisted living facility, you may not have the money to do so. (1)
People over the age of 62 may qualify for reverse mortgages. The amount 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: you not only pay the reverse mortgage fees, but also the interest, which accumulates over the term of the loan. With a regular mortgage, you increase your equity as you pay it off. With a reverse mortgage, it’s just the opposite.
Typically, the reverse mortgage is repaid to the lender when you sell the home or when you die. There may also be provisions in the reverse mortgage that you must live in the house as your primary residence.
The FTC also notes that you must still have enough money to pay taxes, insurance, repairs, and homeowners’ association fees. According to AARP, if you fail to comply with the terms of the loan, which generally 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 will not affect your Social Security or Medicare benefits.”
Some seniors may opt for a reverse mortgage if they don’t want to leave their neighborhood, and buying another smaller property in the same area would mean using a large portion of the proceeds from the sale of their current home. This may be especially true in areas with a high cost of living.
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Since Veronica is over age 59½, she would not face the 10% early withdrawal penalty for withdrawing funds from her 401(k). (3) When you turn age 73, you will be required to begin taking required minimum distributions (RMDs) from your 401(k) unless you continue to work.
However, you will have to pay taxes on the withdrawals you make. Since you are planning to make a large withdrawal to help your mother, and because you are still working, you should consider talking to a tax professional about how much this withdrawal would likely cost you. You may also have to pay taxes on your Social Security benefits if your income increases due to withdrawal.
You should also seriously consider speaking to a financial planner, with the first order of business being your own retirement plan and ensuring you have a solid plan for your future.
Once she is sure that her own finances are in order, Veronica can consider the best way to help her mother. The big considerations here are, first and foremost, finding a sustainable way of life for your mother. This can involve difficult decisions, such as selling the family home.
Veronica’s complicated plan to pay off 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 disaster.
Since Veronica has siblings, who will also be heirs when her mother dies, Veronica should seriously consider the impacts on her mother’s estate by putting a large amount of her own money into her mother’s primary asset.
Veronica and her mother should consider speaking with a real estate attorney about the implications of this decision. They should find out if it would be possible for Veronica to have the money from the estate returned when her mother passes away.
Veronica also needs to check the loan agreement to make sure there are no fees or conditions for repaying the loan.
Reverse mortgages can be desirable options for seniors who do not have enough retirement savings to live on.
However, as Veronica’s mother’s situation makes clear, there are risks to reversing mortgages, including running out of equity, having fewer options if you want to move later, or leaving a financial quagmire for your heirs.
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Federal Trade Commission (FTC) (1); AARP (2); Internal Revenue Service (IRS) (3).
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
