Inheriting a Home with a Reverse Mortgage: A Guide for Heirs
A common hesitation we get from clients who are looking into a reverse mortgage is that they don’t want to affect their child’s inheritance or leave their children with a complicated legal process to go through after their death. The good news is that children have several options.
The balance on a reverse mortgage typically goes up over time as the interest expense is added to the balance each year (unless you make a payment to bring the balance down). Many people are concerned that this will decrease the equity their children will inherit when they pass away because the amount owed to the bank increases each year. However, the home’s appreciation will likely offset this!*
For a $699,000 home with a $275,000 initial mortgage balance, let’s look at 3 scenarios. The “worst-case” scenario has the interest rate higher than the appreciation rate.
The interest is offset even further if the interest rate and the home’s appreciation rate are the same…
And even further if the home appreciates faster than the interest accrues.
So there’s no reason to be concerned that your children are getting the short end of the stick.
What are the options for an heir upon the senior’s death?
The death of a reverse mortgage borrower is considered a maturity event, meaning that the mortgage must be paid in full at this time. Heirs have two options: they can sell the home, or they can purchase it if they wish to keep the home in the family.
If heirs decide to sell, the proceeds from the sale will first pay off the reverse mortgage balance and then the remainder will be distributed according to the wishes of the senior. This is the most common option, as under 2% of inherited homes end up staying in the family.
If the heirs do wish to keep the home, they can pay off the reverse mortgage in cash or refinance the mortgage into their own names. If there isn’t enough equity in the home to refinance (if the reverse mortgage balance was equal to the value), heirs can purchase the home from Fannie Mae at 95 cents to the dollar of the home’s appraised value. So if the home’s value and mortgage balance were at $699,000, heirs could purchase the home for $664,050. (Remember, a reverse mortgage is insured so there will never be more owed on the home than the home is worth; you’ll never be “under water”!) They would then own the home with 5% equity.
* These images are scenarios only meant to illustrate the effect of appreciation and interest on a home’s equity. Appreciation and interest rates are not guaranteed and subject to market.