Reverse Mortgages Grow in Popularity & Availability

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In the past year or so, the word “mortgage” has usually raised negative connotations. Put the word “reverse” in front of it, however, and suddenly you’re referring to one of the more positive personal financing developments in recent memory.

The number of reverse mortgages backed by the federal government rose 41% between Sept. 30, 2006, and Sept. 30, 2007, reports the Department of Housing and Urban Development. The cause of this surge is twofold: Reverse mortgages are more popular, no longer appealing only to those desperate to cover medical expenses, and they’re more available, as more lenders leap headlong into the market.

Getting Behind Your Equity

A reverse mortgage is an arrangement under which a lender makes payments to you for your home’s equity, and the proceeds are generally tax-free. The loan doesn’t come due until you sell the home (at which time you may be able to deduct the interest on your tax return) or die. If the lender sells the house to pay off the loan, it will return any amount exceeding the outstanding balance to you or your estate.

As mentioned, the reverse mortgage market is, if not exploding, at least making some noise. A plethora of bigger mortgage lenders and banks now offer products and, to stay competitive, some have lowered fees and allowed more substantial payouts. A number of lenders even offer so-called “Jumbo” reverse mortgages for more highly valued houses.

What’s more, additional loan backers are getting in on the fun. Previously, Fannie Mae was the primary buyer of reverse mortgages. Now several other banks, including Bank of America, have joined in.

Putting It to Work

For many years, reverse mortgages were looked at as a last resort for those living in valuable houses but lacking cash. These arrangements often provided a way to fund medical expenses, hospital stays and even nursing home residences.

In light of the reverse mortgage surge, however, things are changing. Many higher net worth individuals are using these arrangements to supplement their retirement income, allowing them to take trips or buy recreational vehicles. Some are even taking out reverse mortgages to fund the purchase of a vacation home.

While these are all perfectly understandable uses for a reverse mortgage, don’t overlook the estate planning potential of this product. Let’s say you own a home worth $500,000.

With a reverse mortgage, you could withdraw some equity from the home, thereby reducing the value of your estate. You could then use the money to make annual exclusion gifts to your children or grandchildren.

Under the annual exclusion, you can give up to $12,000 per year per recipient free of gift taxes and without using up any of your $1 million gift tax exemption (or any of your estate tax exemption). Or you could even use the money to fund a 529 college savings plan. 529 plan contributions qualify for the annual exclusion.

Minding the Risks

Naturally, reverse mortgages aren’t risk-free. With the expanded availability of these arrangements has come greater complexity in how interest and fees are calculated. Find a deal with low fees and you may wind up paying a higher interest rate (or vice versa).

And, of course, there are other financing options (such as a home equity loan) you should consider. Nonetheless, the way things are going, there’s never been a better time to look into the feasibility of a reverse mortgage.

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