Using A Reverse Mortgage To Protect Your Home Value

Using your reverse mortgage to protect your home value.

Many consumers have misconceptions about these loans, often leading them to believe that these mortgages have too many drawbacks and should only be used for extreme financial hardship. Our articles addressing the myths about reverse mortgages debunk these misconceptions, however there are benefits to them that most consumers and even industry professionals are not aware of or have not considered, and at times drawbacks that have not been thought through as well. One such benefit is the tax planning options outlined earlier. Another is receiving protection from housing volatility. Yes, it’s actually possible to use a reverse mortgage to protect yourself in part from falling home prices. We will detail how this is accomplished and what the protection can and cannot do for you.

First, let’s discuss how and why a reverse mortgage offers protection from market volatility. This protection is not guarantee of home values, but rather a way of ensuring a portion of the home value is liquidated without ever having to pay back the mortgage or take a personal loss due to the reverse mortgage having a greater payoff than the home value. However there are conditions that restrict what manner of protection you get. To start with the reverse mortgage works as protection from home value losses because you pull cash out from your homes equity that you have complete control over, while never having to make a payment on the mortgage as long as you live in the home. As a result, if home values plummet you have already pulled cash out of your home, and have no obligation to make a payment on that reverse mortgage as long as you live there. You may still use or invest the money you got from the reverse mortgage, but will never be forced to move out of the home or make a mortgage payment as long as you live in the home.

Once you pass away, if the reverse mortgage balance is higher than the value of your home, your heirs may choose to turn the home over to the bank without any personal consequences or financial obligation to them. Regardless of how much the home lost value, your heirs will never have to pay the shortfall if they choose to turn the home over to the lender. You still got your cash, and if you have cash left from the mortgage may leave that to your heirs.

On the flip side, if there is equity in your home and you wish to sell or refinance it you keep the equity, not the reverse mortgage lender. The same holds true for your heirs who may choose to refinance the home and keep it or sell it and get its equity if the home value is greater than the reverse mortgage payoff. In the vast majority of the time the home still has equity remaining when the borrower passes away. For more information explaining how the equity growth works see “what will happen to my equity”

So how much protection can you get? Well it’s not a full protection of home value, but it is a partial one. The loan’s size is determined by location, age of the borrower, and the value of the home. Only a certain percentage of the home value is lent. Assuming you borrow 60% of the home value the protection offered is that you won’t lose more than 40% of the home’s value at the time you take out the reverse mortgage. Basically the loan to value of your loan dictates how much protection you have.

So what conditions apply? First, if you owe more on the home than its worth and you wish to move you would have some issues to deal with. If the sale proceeds don’t cover the loan balance you will have no obligation to pay the shortfall, however no equity will come your way and you will need to work with the lender to transfer title to them. This is a key point as reverse mortgage differs from a conventional mortgage in that the lenders only recourse is against the home only, not against the home and the person. As a result the lender cannot get a default judgment against you to pursue any losses they take. Next, once you pass away your heirs will have a choice to keep the home or turn it over to the lender. They have six months to decide and act. If they are set on keeping the home and you owe more than its value they would have to pay the shortfall. However they are free to turn the home over to the bank and pay nothing.

In all reality it is very rare for a reverse mortgage to outgrow the value of the home. In most cases the equity in the home grows and the borrower can sell anytime without any worries, and the heirs get the equity later should they decide to remain in the home. However, as recent times have shown, it is possible for home values to decline. That coupled with an increasing payoff balance on the mortgage can result in a reverse mortgage balance being higher than the home value.

Finally, why does this protection work? It seems too good to be true at first glance. It works because of the structure and backing of these loans. First, FHA insures most reverse mortgages. The FHA insurance paid at the closing of the mortgage and its ongoing service fees pays for insurance against negative equity losses to the lender. FHA insurance is a cost that shows under the term MIP on the closing statement. That fee is subtracted from your loan proceeds. Next, because you may only borrow a percentage of the home value it is rare for this insurance to pay out- but has been more commonplace in the past few years. The protection is only one benefit to reverse mortgages. Both benefits and drawbacks are present. While a reverse mortgage has many benefits, be sure to know its costs and drawbacks. This tool is not right for everyone. Talk to a professional for more information, or visit my site for a complete reverse mortgage guide.