A cheaper reverse mortgage alternative

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Taking cash out of your home through a reverse mortgage can be expensive. Closing costs, lender fees and certain mortgage insurance costs must be paid upfront, and you face interest charges and ongoing mortgage insurance premiums over time.

And, a 2015 report from the Consumer Financial Protection Bureau said the potential risks of reverse mortgages (namely, that you can lose your home) mean they’re not always the right choice.

“While reverse mortgages can help some older homeowners meet financial needs, they can jeopardize retirement security if not used carefully,” the bureau wrote.

Given the costs and concerns, some retirees turn to a family member instead of a financial institution, for what’s known as a private reverse mortgage.

How it works

Adult children or other willing family members with sufficient means can finance a private reverse mortgage. With the loan secured by a deed of trust, the cash can be paid in a lump sum, a line of credit or monthly installments, just like a reverse mortgage from a commercial lender.

The loan must be documented and filed with the Registry of Deeds. A certified public accountant or an estate planning attorney can handle the paperwork.

Intra-family loans have several advantages over conventional reverse mortgages, according to research from Consumers Union, California Advocates for Nursing Home Reform and the Council on Aging Silicon Valley. The upfront costs are much lower, for one thing, while the amount of equity homeowners can pass on to their heirs is higher.

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.

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