The Wall Street Journal recently ran a piece entitled “The Case for Being Your Mom’s Banker” that proposed children establishing a private reverse mortgage for their elderly parents in order to avoid the closing costs charged by a traditional reverse mortgage lender.
Three types of reverse mortgages: government-insured, proprietary, and private.
Government-insured reverse mortgages are offered through a bank and are insured by FHA. In the event the amount owed on the reverse mortgage at the end is more than the home is worth, any losses the bank incurs are covered by FHA. Because of this, you will qualify for more money with a lower interest rate but there is a sizeable fee charged by FHA for this protection. These days, substantially all reverse mortgages are the government-insured variety.
A proprietary reverse mortgage is one that is offered by a bank but is not backed by FHA. These loans don’t have some of the limitations of the government insured loans but you will qualify for less money and pay a higher interest rate since the bank is on the hook for any losses that may occur.
A private reverse mortgage is when a family member acts in the same capacity as a reverse mortgage lender.
Complications with private reverse mortgages
While funding your parent’s retirement yourself is certainly an option to explore, there are many complications associated with private reverse mortgages that don’t exist when a reverse mortgage is obtained through a bank.
Ties up capital
First, funding a private reverse mortgage for your parents ties up your money. What happens if your situation changes? What if you lose your job, get a divorce, or have a medical emergency? You may need to use the money earmarked for your parents under the private reverse mortgage for other purposes.
Even if none of these events occur, the money diverted to your parents could have been put into an IRA, college fund, or otherwise invested at a higher return than could be charged on the private reverse mortgage.
Decline in property value
Second, the property value for the home that secures the private reverse mortgage may go down. With a proprietary or government-insured reverse mortgage, this is the bank’s or FHA’s problem. With a private reverse mortgage, it’s your problem.
Possible gift taxes
Third, as the WSJ article points out, there is the risk of triggering gift taxes. The $13,000 a year allowed by the IRS per individual is not much money and it is likely your parents would need more than that to maintain their quality of life. Any more than that and you may trigger gift taxes.
Conflict within the family
Finally, a private reverse mortgage may create conflict within the family. There may be implied “strings” on the money. If the parents take a vacation or splurge on a car, will you feel you are being taken advantage of? Will you insist on having all decisions regarding your parents run through you even if another sibling is the primary on-site caregiver?
Other siblings may resent or be jealous of you providing the reverse mortgage because you have the money to do it and they don’t. Or, even worse, they may suspect you of taking advantage of your parents by charging interest on the loan or thinking that you are trying to get more money from their estate when they pass away.
Even if you are an only child or have none of these issues with your siblings, your parents may feel a loss of independence, like they are being a burden to you, or that the roles have reversed by relying on you for money. They may not like feeling as if they need to get permission from you before making a major purchase.
Family dynamics can be very complex and there is no telling what ramifications one child making a private reverse mortgage might have on the rest of the family. For older adults in their later years, it is very important that their children get along. The last thing they would want is to be the cause of damaged relationships between their children.
Traditional reverse mortgage easier and cleaner than private reverse mortgage
A proprietary or government-insured reverse mortgage is an arms length transaction entered into by your parents with a bank on their own home so these family issues are eliminated or substantially reduced.
Because of the complex considerations of a private reverse mortgage, it is often easier and cleaner to obtain a reverse mortgage through a lender despite the higher closing costs (which, by the way, are not paid out of pocket but financed by the loan).
Mark Schmidt has been a reverse mortgage specialist since 2004. In that time, he has guided hundreds of seniors through the reverse mortgage process. He is a veteran in the industry at a time when many others are “jumping on the bandwagon” of reverse mortgages.
A graduate of the University of Illinois, Mark also has an MBA from Loyola University and twelve years as a financial analyst with Merrill Lynch and Bank of America. To understand the needs of his clientele better, he was designated a Certified Senior Advisor in 2007 by completing additional studies of the social, physical, and financial aspects of aging.
Mark is the reverse mortgage expert for www.caregiverlist.com and is the author of “Reverse Mortgages: Facts and FAQs” which was in Amazon.com’s top five list for reverse mortgage books before selling out.
You can email Mark directly by clicking here.