A costly proposition
Information from the U.S Department of Housing and Urban Development (HUD) provides a glimpse of how expensive regular reverse mortgages can be. You'll pay a loan origination fee that typically equals 2% of the first $200,000 of the home's value and 1% of the remaining balance, with the total capped at $6,000.
Add up to another 2.5% of the home's value for the initial mortgage insurance premium, plus $1,000 or more for an additional laundry list of costs that include appraisal fees and title insurance.
Keeping the loan in the family can make tapping into the home's equity more affordable, but too much of a bargain might make the family member/lender susceptible to the gift tax. To steer clear, make sure the interest rate at least matches the applicable federal interest rate, or AFR. The Internal Revenue Service updates applicable federal rates on its website monthly.
The applicable federal rates for July 2016 were 1.43% for midterm loans and 2.18% for long-term loans. Benny Kass, an attorney with the firm Kass, Mitek & Kass in Washington, D.C., says the midterm rate would apply if you are lending the money only for a couple of years; otherwise, you should use the long-term rate as your guide.
The Consumers Union report suggests using a spreadsheet to keep track of each family member's investment in the loan and the interest due.
Determine if it's affordable
A private reverse mortgage may not work for everyone. Consumers Union, which is the policy and action arm of Consumer Reports, advises that the family first assess how much money the homeowner needs and whether the potential family lenders can afford to provide it.
As one financial adviser points out, an intra-family loan may not be feasible when all the numbers are crunched.
"Sometimes the kids can't afford to provide the mortgage to the parents," says Debra Neiman of Neiman & Associates Financial Services in Arlington, Massachusetts. "They have too many obligations of their own, and they don't have the capital to provide the funding."
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When you finance a reverse mortgage for a parent, you're purchasing a majority stake in the home, Neiman says. For that reason, you may want to evaluate how much the property will be worth. The type of dwelling, its appraised value, its location and the health of the local real estate market all factor in.
"If the child is going to do this, it's an investment on their part," Neiman says. "They are going to end up owning a property. They are taking an equity stake in the property now, and when the parent passes on, they'll have the remainder of the equity."
Prevent family disputes
Because business transactions within the family can be sticky, communicating with other family members about the plans for the home when the parent dies or is no longer able to live in it is also important. If the lending family member later wants to sell the property, but other siblings or a surviving spouse who holds the remaining interest in the home object, there may be friction, Neiman says.
But as long as a private reverse mortgage won't disrupt peace in the family, it may be just the right choice for seniors seeking peace of mind through affordable retirement living.