Dear Dr. Don,
An elderly family member owns her home outright. It is worth approximately $1.5 million. In three years, she will need to supplement her monthly income due to an annuity that will end. She will need $6,000 per month to meet her requirements for five years. Should she take out a home equity type of loan or a reverse mortgage?
— John Juncture
There’s a host of issues not discussed in your letter. Generally, the homeowner has to be living in the house for the reverse mortgage not to come due. She’s presumably living in the house now, but will she be there three years from now? Will she still live there in the five years following that, when she needs the money from the reverse mortgage?
You haven’t made clear why she needs the income for only five years. Is it possible that she’ll need that level of income for an even longer period of time?
She could buy a lifetime annuity contract from the reverse mortgage proceeds (which she will get at the closing) to meet her income needs over her lifetime and not have to worry about whether she was still in the house.
The proceeds from a reverse mortgage, however, can negatively influence her eligibility for Medicaid and Supplemental Security Income.
One caution is that some financial service providers have cross-sold annuity contracts with the proceeds of the reverse mortgage. They have the homeowner use the proceeds of a reverse mortgage to buy an annuity contract. This can be appropriate if the annuity contract is appropriate.
But it can become a financial nightmare if the contract is not appropriate. This is a good reason to work with an independent fee-based planner in reviewing the decision and before signing any contracts.
Now, let’s return to your original question. The advantage of a home equity line of credit is the lower closing cost. The disadvantage is coming up with the payments on that loan, even though the loan is interest-only for the initial draw period on the HELOC.
The best type of reverse mortgage — known as a home equity conversion mortgage, or HECM — doesn’t have a monthly payment. Instead, enough equity in the home is held in reserve so it will be available to pay the interest expense when the loan ends.
At an estimated $6,000 a month over 60 months for a total of $320,000, her income needs fall below the new national limit for federally backed loans of $417,000 in most markets and $625,000 in high-cost areas.
The Bankrate feature “New rules rev up reverse mortgages” does a great job in explaining the provision of the HECM. While proprietary reverse equity mortgages also exist, a HECM program loan is typically the better choice.
It can get pretty complicated to decide between a fixed-rate loan and an adjustable-rate loan or whether it’s best to take the money as a lump sum or as monthly draws on a line of credit. I’d suggest following the recommendations in the Bankrate article and read up on the mortgage by getting the AARP guide “Home Made Money.”
Also, consider consulting with a fee-based financial planner on the decision. The National Association of Personal Financial Advisors provides a listing of fee-based planners. Bankrate can also help you find a Certified Financial Planner.
While your relative keeps any remaining equity in the home not spent on accumulated principal and interest expense, there could be some other financial alternatives to the HECM. This is especially true if your relative wants to keep the home in the family and the family is willing to finance her income needs. An estate-planning attorney could structure a plan to accomplish that goal.
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