How are Reverse Mortgages Settled After the Borrower(s) Passes?
Most folks are familiar after going through the application process for a reverse mortgage that if the applicant leaves the home or passes away, the reverse mortgage will come due prior to expiration. However, the mechanics of the actual process of estate settlement in the case where the owner passes away is discussed very little because death is difficult to talk about. Uncomfortable as it may be, having a good understanding of the possibility is key in planning for a reverse mortgage. After all, two things are certain in life: taxes and death.
A Quick Overview on Reverse Mortgages
So, as a reminder, a reverse mortgage is essentially a loan against one’s home equity. The homeowner owns the home and uses the equity as the basis for a loan. A lender funds the loan against the value of the equity, and the loan is not paid back until the reverse mortgage term expires. Interest builds up over the duration. When the term is expired, the loan is paid in full, or the title of the home is turned over to the lender in exchange for the loan payment. The lender then sells the home to recover the loan proceeds. Any difference that exceeds the loan value is paid to the owner, partner or next of kin.
What Happens After the Borrower(s) Pass Away?
It used to be that when any borrower listed on the loan passed away, the loan became due. This created a big problem because usually there was a surviving partner who was too advanced in age to earn sufficient income to cover living costs and a loan payment in full. Many surviving spouses found themselves being forced out of their home to satisfy a reverse mortgage payment. However, the federal law was changed, and now a surviving spouse can remain in the home financed until he or she leaves or passes as well.
When Borrower(s) Pass, the Loan Comes Due
Generally, when the borrowers listed pass away or leave the home, the loan comes due and has to be repaid. Otherwise, the lender has a right to assume the title to the home used to finance the reverse mortgage.
Heirs Will Hear From the Loan Provider
Where next of kin are involved, the executor of an estate, lenders, and the legal process confirm whom the beneficiaries are as well as heirs. These folks are notified and provided 30 days’ time to decide what they want to do with the estate, the loan, and the payments due.
Your Initial 6 Month Loan Payoff Begins
Generally, the next of kin or estate owner has a 6-month period to raise the funds to pay a loan in full. There are some options on how to extend this payment due, but they do have requirements that must be met. It’s not an open-ended option for modification. After all, the lender has likely been waiting for a while to collect on the outstanding reverse mortgage due.
Understanding the Interest
Unlike a regular loan, a reverse mortgage is not being paid back for the life of the loan. Instead, the payment is delayed and the interest charged for the loan is accruing or adding up in a holding account. When the loan expires, the full base payment and aggregated interest is due in one payment, often making the final loan a much bigger figure than what was originally borrowed.
The Good News
One advantage that works for the owner or next of kin is that the lender does get an advantage if the market happens to drop. Where a loan amount outstanding ends up costing more than the value of the home, the difference is not passed on as an obligation to the next of kin. The lender just ends up taking a loss if the next of kin decide not to pay and instead turns over the title of property to satisfy the loan.
What are Your Options as Heir?
So, to recap, a spouse, heir or next of kin has a couple of clear options available: pay the loan off in full, let the title pass to the lender by walking away from it, or forgive the loan through a deed in lieu of foreclosure.
Pay any Balance
Obviously, the way one keeps a property “in the family” is to simply pay off the loan amount due. The lender isn’t usually interested in taking a property. It’s a hassle to deal with title, clear it, prepare the property for sale and finally liquidate it to another buyer. And there’s no guarantee that the lender will get a full recovery of the loan and interest, especially when the real estate market takes a downturn. Because of this fact, some lenders in hard markets may be receptive to working out additional payment plans if they feel the agreement will get them a full payment soon.
Walk Away From the Property
Walking away from a property is legally known as “abandonment.” In doing so, the owner may still end up with legal obligations down the road, but in most states the lenders generally just accept the property and call it a day. Again, going through full litigation to pursue a balance is a hassle and costs money, and most times the value of the home seized by lien more than compensates the lender. In good markets they can even make an extra profit on an abandonment sale. It’s usually in really bad down markets where the lender takes a loss that it might sue for the remainder from a runaway owner. However, anything sued must be reduced by what was already recovered in a sale before the collection.
Complete a Deed in Lieu of Foreclosure
A third alternative is for an owner to let the home go into foreclosure. This is where the lender triggers a legal seizure of the home with a present owner. Doing so brings the matter to court where a judge will be expected to then seize the home to satisfy the loan due. However, the owner could ask for a forgiveness settlement from the lender before trial, and many lenders will take a home, forgiving the rest of the loan due. This closes the matter with the lender, but the owner needs to remember that a forgiveness can be treated as income by the IRS, which means it is taxable for what is absolved.
What are Your Options as a ‘Surviving’ Spouse?
The surviving spouse under current legal authorities is now protected and cannot be forced out of a home to satisfy a loan when the other spouse named on a loan passes away. The same protection may apply to a spouse not named on a reverse mortgage as well, but this could require some legal representation and a good attorney to protect one’s rights. The non-party spouse has fewer rights than a contractual one, and the law on the matter is not an automatic protection for such cases.
The Key is to Communicate
Nothing in life is ever certain. We plan, we strategize, and we keep an eye out, but life has a way of surprising us. A passing can be disruptive but it can be managed. To make sure spouses keep up with their information needs during a reverse mortgage, it’s always good to check in annually or biannually with a financial professional and do a check up on loan status and responsibilities, just like a medical checkup, as a preventative measure.
*Reverse mortgages are loans offered to homeowners who are 62 or older who have equity in their homes. The loan programs allow borrowers to defer payment on the loans until they pass away, sell the home, or move out. Homeowners, however, remain responsible for the payment of taxes, insurance, maintenance, and other items. Nonpayment of these items can lead to a default under the loan terms and ultimate loss of the home. FHA insured reverse mortgages have an up front and ongoing cost; ask your loan officer for details. These materials are not from, nor approved by HUD, FHA, or any governing agency.