Reversing the parent-child model

Some buzz has circled recently around one type of reverse mortgage that gives new meaning to the phrase: “All in the family.” Private reverse mortgages, which place a family member in the role of financier, are being talked about as one alternative to government-insured or proprietary products for seniors.

But, setting up a private reverse mortgage with one’s parents takes some effort, according to an estate-planning attorney in Westlake Village, Calif., quoted recently in a Wall Street Journal story. He recommended legally recording the loan so other family members can’t attack the arrangement after the parents pass away. He also advises paying for a title search to make sure there are no other liens on the house before making the loan.

In another advisory, one financial planner in Boston tells siblings to set up a private reverse mortgage for their parents using a limited partnership, rather than buying their house, when there has been substantial equity gain over time. In this way, the offspring benefit from a “stepped-up basis,” when the parents are gone, meaning there would not be capital-gains taxes when they sell, he explains.

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Experts advise families to consider the array of potential complications with private reverse mortgages. Among them that:

  • it ties up capital;
  • there may be a decline in property value;
  • gift taxes may have to be paid and, last but far from least;
  • it could product conflict within the family.

On this last danger, experts say there could be a palpable “power shift” from parent to adult child. Would the financing son or daughter, for example, feel entitled to make decisions regarding their parents’ spending? Other issues include whether siblings would be resentful or jealous and whether parents might feel a loss of independence under such an arrangement.

Offering his assessment of private reverse mortgages, Rick Jurgens, advocate and investigative reporter with the National Consumer Law Center, Boston, said there are “legal dynamics and family matters” to consider. I’d be nervous about any third-party ‘hawking’ a private reverse mortgage,” Jurgens cautioned, adding that “it sounds like equity stripping of past” eras.

Written by Neil Morse

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  • If the family RM is set up properly, why would there be any gift tax? Tax planners call transactions with parents that result in taxable gifts in excess of annual exemptions as “upstream gifts.” With rare exception, upstream gifts should be avoided at all costs since they will generally result in not only potential gift tax or higher estate tax to the children but also higher estate taxes to the parents.

    In observing one family consider a family RM, it became very apparent that the child was modestly wealthy and even though he could provide the initial cash needed, he could not make the long-term cash reserve commitment the parents might need and which a HECM would supply. He felt that the parents could always get a HECM later on.

    In discussing the proposal there were four areas that stood out. The first was the son and parents were assuming the HECM program would be there in the same form or better when the parents needed it. Second, there was a belief that the home would increase in value over time. Third, there was an unrealistic assumption that if additional cash was needed, the parents could readily and easily obtain it within days of applying for a HECM. Finally it was clear the daughter-in-law was clearly not comfortable with providing the family RM.

    The family went through with the family RM. Whether or not it has worked out is not known but based on the drop in home values and the 10% reduction to principal limits, the HECM may not be availabe unless the son forgives a portion of the family RM. One thing that is sure, the daugher-in-law would have found little comfort in the current economic and HECM environment.

  • Very well explained. I've seen far too often the assumption of the future. It is surely one of the reasons for caution with the fixed rate products.

  • Very well explained. I’ve seen far too often the assumption of the future. It is surely one of the reasons for caution with the fixed rate products.

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