Two solutions for elderly parents who are house rich but cash poor
Written by Bruce Yates, Financial Advisor
A Common Financial Conundrum
If your parents are getting on in years, they may find themselves facing a situation shared by many older Americans. The majority of their wealth may be tied up in the house they bought decades ago, while their liquid assets—cash and securities that can be quickly converted to cash—may be very limited by comparison. Although their home may be valuable, the lack of liquid assets may mean that they struggle to pay for basic living expenses, let alone potentially having ever-increasing home maintenance costs and property taxes. Let’s examine two possible solutions:
Solution 1: Directly Subsidize Them
If you and/or your siblings can afford to, the simplest solution is to consider financing some of your parents’ living expenses directly. A few years before my own mother passed away, she voiced her concern over how rapidly she was draining the principal of her modest investment portfolio, and she feared having to sell her home and move. I told her not to worry because if/when she ran out of money, my siblings and I would provide her with enough income to continue living there. She never reached that point, but the last time I saw her before her death, she said that ever since that conversation with me, a great weight was lifted from her mind, and she was able to stop worrying about money. In other words, just knowing that we could help her was a valuable gift.
Of course, you should only promise this if you (and/or your siblings) could follow through, and that isn’t an option for everyone; after all, you may not have financial means to help your parents and maintain your own family’s financial security. But if you can, consider these two factors:
- Your parents’ home will probably be sold after they die, so some or all of what you give them may be reimbursed to you as an inheritance at that point.
- You could structure the money you give them as a formal loan that accumulates (along with interest) and gets paid back whenever the house is eventually sold. This is an especially good approach if some siblings can afford to help, but others can’t. If you choose this approach, have your attorney draw up as a formal mortgage loan. Also, be sure that your siblings or other family members understand the arrangement, so that they aren’t surprised or feel resentment towards you down the road for trying to take “their” inheritance.
Solution 2: Tap Home Equity with a Reverse Mortgage
What if you and your siblings can’t afford to help support your parents? You might explore one of the most flexible ways of tapping your parents’ home equity—the reverse mortgage.
A reverse mortgage, specifically the HECM (Home Equity Conversion Mortgage), is an increasingly popular retirement planning tool for older Americans. This type of mortgage, available only to borrowers age 62 and older, is attractive in part because it doesn’t require monthly mortgage payments. Insured by the Federal Housing Administration (FHA), reverse mortgages allow homeowners to convert a portion of their home equity into usable cash.
When reverse mortgages first appeared decades ago, they contained numerous pitfalls (that senior citizens didn’t comprehend), so they got a bad name. Laws passed since then have eliminated those abuses (for instance, a person can never be forced out of their home by living too long, even if the loan balance ends up exceeding the home’s value). HECMs were created with the idea that proceeds from the mortgage would be used to pay for essentials like health care and living expenses, but the proceeds can in fact be spent on anything, e.g., home renovations, travel, or even a new car. Note, however, that if you urgently need money, this may not be the answer; HECM requirements may restrict the loan’s availability for up to a year.
A reverse mortgage isn’t the answer for everyone, but it is now a viable option for many families facing long-term cash flow challenges. In fact, it can be a near-perfect choice for seniors who meet certain criteria. In addition to being over age 62, the homeowner should have no plans to move in the foreseeable future. They must also have the means to afford upkeep and maintenance of their home,* without using loan proceeds to do so.
Pros and Cons of Reverse Mortgages: (Source: www.reverse.org)
- Provides flexible disbursement options (e.g., monthly income, lump sum, line of credit)
- Homeowner stays in the home without making monthly mortgage payments*
- Eliminates existing mortgages (including HELOC)
- Heirs are not personally liable if payoff balance exceeds home value
- Heirs inherit remaining home equity after paying off the reverse mortgage loan
- Proceeds are not considered income or otherwise, although property taxes must continue to be paid **
- Interest rates may be lower than other options
- Value of estate/inheritance left to heirs may decrease over time as proceeds are spent and interest accrues on the loan balance
- Fees are typically higher than with a traditional mortgage
- The reverse mortgage must first be used to pay off any existing mortgages in order for you to have access to loan proceeds for any other purpose
- Although a reverse mortgage loan generally does not affect eligibility for Social Security and Medicare, needs-based government programs such as Medicaid may be affected**
- Reverse mortgages are not well understood by many people
How much can you borrow on a HECM reverse mortgage? That depends on several factors, including your (and your spouse’s) age, the value of the home, and current interest rates. As of January 1, 2018, the maximum home value you can borrow against is $679,650, even if your home is worth more than that. The portion of that value you can borrow depends on something called a Principal Limit Factor (PLF). PLF is similar to the more common real estate term “Loan-to-Value” (LTV), the portion of your home’s value you can borrow.
For example, if you are age 62 and your spouse is 60, and the going interest rate on a HECM is around 4.75%, your PLF might be roughly 40%. (Wait, you’re thinking, you said I can’t get a reverse mortgage until 62; that’s true, and a 60 year old spouse can’t be on the loan, but his/her age impacts the PLF for you—the 62 year old borrower—because he/she can remain in the house after your death for the rest of his/her life.) If your home is worth $400,000 in this case, you could initially borrow on a HECM roughly $160,000 ($400,000 x 40%). If your home is worth $679,650 (or anything higher), you could initially borrow roughly $271,860 ($679,650 x 40%).
In general, the older you are (or your spouse is, if he/she is younger), the larger is the portion of your home’s value you can initially borrow (the PLF or LTV) on a HECM. Conversely, the higher interest rates are when you initiate a HECM, the smaller the portion of the home’s value you can bottow. The calculation is actually more complicated, and the amount available in years after you initiate a HECM may increase over time, but this is the general idea. For the figures applicable to you, it is important that you get advice from a reverse mortgage expert.***
Because reverse mortgages use the equity in a borrower’s home as collateral, the loan comes due when the borrower (or spouse, if he/she lives longer) either moves out or dies. At that point, the home generally must be sold within 6 months; the proceeds go first to repay the loan, and then any excess goes to the homeowner or heirs. Again, reverse mortgages aren’t for everyone, but they have become increasingly useful in planning for senior citizens with lots of home equity, but increasing difficulty meeting cash flow needs.
Seeing our parents struggle with their finances is hard. We care deeply about their well-being, and want to make sure we do everything we can to support them as they get older. Consider these two possible options, and sit down with your parents to discuss them. After all, their retirement should be spent relaxing and enjoying life, not fretting about how they’ll pay next month’s bills.
Bruce Yates is a founding shareholder at Viridian Advisors in Bothell, WA. Bruce has been a financial advisor, specializing in physician couples, for almost four decades. He is passionate about helping clients build, maintain, and pass on wealth—so they can spend their time on family, philanthropy, and other interests, rather than worrying about their money.
* You must live in the home as your primary residence, continue to pay required property taxes, homeowners insurance and maintain the home according to Federal Housing Administration requirements. Failure to meet these requirements can trigger a loan default that may result in foreclosure.
** Consult your financial advisor and appropriate government agencies for any effect on taxes or government benefits.
*** Viridian neither sells nor receives referral fees for reverse mortgages. We are not affiliated with reverse.org nor any of its commercial partners. If you contact us, we know several reverse mortgage experts to whom we can refer you.