Washington Post Debunks Reverse Mortgage Myths

It is time to take another look at reverse mortgages as a retirement resource, a Washington Post article published this week writes. Once holding a negative reputation for high upfront fees, and the “many misconceptions about how they work,” a reverse mortgage could provide an ideal way to tap into home equity for some baby boomers, the Post says.

“…you need to investigate the ramifications of the program on your finances,” the article warns. “Your ability to qualify for certain need-based programs such as Supplemental Security Income or Medicaid could be hurt by the additional funds received from a reverse mortgage. Also, this is not a good idea for people who are seriously ill or who plan to move in a year or two, because the cost of the loan would be high.

As long as you don’t fit into those categories, the benefits are numerous.”

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The article details the mortgage insurance that the Federal Housing Administration uses to guarantee the loans as well as the negative amortization process and difference between fixed rate and adjustable-rate options. It also goes on to debunk common myths:

“Common misconceptions about reverse mortgages are numerous. Reverse lenders cannot kick you or your surviving spouse out of your home so long as you continue to pay your property taxes and insurance. The reverse mortgage continues until the last surviving borrower sells, moves or dies. Another myth is that your heirs will be stuck paying off your reverse mortgage. Not true. Neither you nor your heirs will ever have to pay off a reverse mortgage out of pocket. If, at the time the reverse mortgage becomes due, your home still has equity, your heirs can sell your home, pay off the reverse mortgage and keep the excess. If your home does not have any equity at that time, your heirs can just walk away with no personal liability.”

Read the full Washington Post article.

Written by Elizabeth Ecker

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  • The only part of this article I don’t like and our industry says it alot, is “If your home does not have any equity at that time, your heirs can just walk away with no personal liability.” It’s not that simple. While the heirs are not liable in an under equity situation the lender will start foreclosure preceedings to gain title so that they can sell the property. This can leave a bad taste in the mouth of the heirs. I understand the process is necessary, but we need to educate the borrowers on how it works so they can prepare their families.

    • Mr. Tomlin,

      I wish that is all there was to it.  Today I just spoke with a sole heir, sole successor trust beneficiary, executor, sole successor trustee who was also the reverse mortgage originator on the loan.  The originator was the sole child of his parents.  The HECM was originated by a parent of the originator. 

      I have heard many originators claim they follow through even on termination but their descriptions of purgatory sound more like Nirvana.  It always makes me wonder if they have contacted the borrower a few years AFTER the HECM was completely terminated.  But then again, things have not always been handled correctly from an income tax point of view.  

      Here is finally a case where all the things have been done right.  

      The house was sold in a short sale.  The balance due on the HECM at termination was over $350,000.  The home was sold in a short sale for $145,000 and the servicer correctly issued a Form 1099-C for over $205,000.  The income tax liabilities to the fed and state will exceed $35,000.

      Oh, by the way, the accrued costs were less than $70,000 mainly because most of the proceeds were taken just months before the passing away of the borrower.  Home values in that area had collapsed from the time that the HECM was originated.

      “Reverse mortgages proceeds are tax-free cash.”  While that will always be the case when the HECM is repaid in full, it may NOT always be case when the HECM is not paid in full as it was not here.  What is always true with a fixed rate HECM is that there is no income tax liability when proceeds are received.  It may not always the case with an adjustable rate HECM but without appraised values at the time of payouts, proof of taxability for the IRS would be all but impossible in MOST cases.

      Myths are just that myths.  Income taxes are just that income taxes.

      • Hello Jim,

        I just want to make sure I understand what you are saying.  The HECM Servicer issued a 1099-C to the estate?  I did not think that they could do that given the way that HECM’s are sold.  As counselors, we have been told that the only tax consequence to one of these loans is that, if the HECM was paying off a mortgage, that the recipient would no longer be able to take a mortgage interest deduction on their taxes.  That, because it is a non-recourse loan, the Servicer can make no further claim on either the estate or the heirs above and beyond the value of the property.  If the Servicers can and do start sending out 1099-C’s, that will cause some major issues.  It will also be seen by the heirs as a way to come after the proceeds of the loans by taking part of their inheritance, above and beyond the value of the property.

        If one of my client’s heirs received such a 1099-C, I would recommend suing the Servicer over it.  Why is the client paying mortgage insurance for the life of the loan if not to prevent such a thing from happening by making the Servicer whole?  Given that the client has made those payments, and that the Servicer is made whole from the mortgage insurance, I don’t understand why a 1099-C would be issued.  The client has not had the loan forgiven, the chance that it would happen was part of the very structure of the loan.

        I hope someone looks into this and can get us a definitive answer quickly.

        Frank J. Kautz, II
        Staff Attorney

        Community Service Network, Inc.
        52 Broadway
        Stoneham, MA 02180
        (781) 438-1977
        (781) 438-6037 fax
        [email protected] –work
        [email protected] –private

  • Frank,

    How does a HECM differ from any other nonrecourse mortgage?

    Federal statute, 15 USC 1602(bb), makes all reverse mortgage transactions, nonrecourse transactions.  A HECM is referred to as a reverse mortgage several times in HUD HECM Handbook 4325.1.

    Either lenders or HUD could go to court to get a deficiency judgment against the borrower if it were not for the terms of both notes which specifically state that the borrower (estate, heirs, etc.) has no responsbility for repayment [and federal statute].  FHA insurance has not, does not, and will not make a HECM nonrecourse.  Both federal statute and the notes themselves make this mortgage nonrecourse.

    Who is the liability for payment of FHA insurance against?  We had a period when lenders did not pass through their upfront cost for FHA insurance to borrowers.  It is a lender cost passed through to borrowers no differently than lender title insurance.  It is not in the least like mortgage life insurance.

    If a lender commits fraud, fails to comply with rules, etc., FHA is not required to honor its insurance commitment and as stated by  National Office at times has not “honored” it.  Does that change the nature of this mortgage to recourse?  It is nonrecourse by law and by the very terms of its notes.

    What tax law denies an interest deduction based on nonpayment?  IRC Regulation Section 1.1001-2 comes into play whenever there is a taxable transfer of the collateral securitizing a nonrecourse debt and along with such transfer, some portion of a nonrecourse debt is forgiven.  In that case the regulation makes such forgiveness not ordinary income under IRC Section 62(a)(12) as is the case with all cancelled debt generally (subject to the exclusions available under IRC Section 108) but rather proceeds from the sale of the collateral with none of the exclusions under IRC Section 108 available.  This position is well established by the Supreme Court under its Tufts decision (461 U.S. 300).  The James A. Allen decision deals with FHA insurance specifically (856 F.2d 1169).

    When it comes to borrowers, what is so unusual about the nonrecourse nature of a HECM?  FHA insurance has absolutely nothing to do with it; otherwise, HECMs would be contingently nonrecourse depending upon FHA honoring its insurance obligation based on lenders meeting HECM requirements.  What a mess that would be. 

    •  Jim,

      Thank you for the explanation, and in particular the cites.  This is one of those times that I really wish that what we were told in training matched reality but doesn’t quite seem to.  I could easily see this becoming a major problem for some borrowers down the line.  They are told it is non-recourse and that there are no tax consequences and along come the tax consequences later.

      On the other hand, I still think that it could be argued to the IRS and to the courts that there is and should be no debt forgiveness when a loan is entered into that is set up so that it can exceed the value of the property.  Especially one where the borrower and the lender contemplate such a possibility/probability and take out insurance to cover such an eventuality.  To do otherwise changes the rules of the game after it has already started.  (Which Congress does regularly anyway with the tax code, so I really have no reason to complain.)  Alternatively, some smart congresscritter should pick this up for AARP and change the tax code to specifically and totally exempt such potential claims as they relate to HECMs and the issuance of 1099-C’s.

      Once again, Jim, thank you for breaking it down for me and especially for the cites.

      Frank J. Kautz, II
      Staff Attorney

      Community Service Network, Inc.
      52 Broadway
      Stoneham, MA 02180
      (781) 438-1977
      (781) 438-6037 fax
      [email protected] –work
      [email protected] –private

      • Frank,

        Now that the industry is headed in the right direction it is time for me to begin looking in ways for some heirs to mitigate their tax liability.  To be a nimble tax advisor one must look at many, many scenarios.  

        When there are multiple borrowers, there can be multiple heirs, inheriting at different times in the HECM life cycle.  It has been very strange to me that those who talk about holding their borrowers hand to the very end, do not mention more than one time when a property changes title due to inheritance.

        Today blended families are a larger and larger segment of society.  Some multiple borrower situations are not spouses but siblings.  In each of these situations, inheritance by non-borrowers can take place before the death of the last surviving borrower resulting in heirs having very different adjusted basis in the home at HECM termination.

        Right now I have just started looking into the Crane decision and the Mayerson case to see how final heirs (and perhaps earlier) can increase adjusted basis beyond market value as the date of the death of the applicable borrower.  The IRS has reserved the right to challenge positions based on the Mayerson decision in Revenue Ruling 69-77 so I have my work cut out for me.  This is the position I enjoy being in, finding ways to mitigate tax rather than explaining basic tax law.  By the way Wikipedia does a pretty good job of defining the tax issue on nonrecourse debt in its description of nonrecourse debt.

        Now let the fun begin.

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