By Kenneth HarneyReal Estate WriterJune 5, 2015
It’s a quandary many families face: Mom and Dad, now retired, need more money to live on and want to remain in their home but are wary about signing up for a traditional reverse mortgage with a bank. (Yesterday, the federal Consumer Financial Protection Bureau released a cautionary report on these loans and their advertising.)
Now there’s a new option for people in this position: a family-funded reverse mortgage that’s custom-tailored to the needs not only of Mom and Dad but to the needs of one or multiple relatives who’ll serve as lenders.
Before I lay out the pros and cons of the “Caregiver Mortgage” from National Family Mortgage — a line of credit secured by the home — let me offer a brief explanation of reverse mortgages and how they work.
How Reverse Mortgages Work
A reverse mortgage provides cash payments to a homeowner age 62 or older in the form of either periodic disbursements or a lump sum, based on their age and home equity. Traditional bank-funded reverse mortgages make the payments as long as the borrowers live in the house. Once a borrower dies or moves out, the house must be sold and the bank then often takes large chunks of the sale proceeds in the form of compounded interest, repayment of all disbursed funds and fees.
Intra-family lending has no credit score requirements, debt-to-income ceilings or other hurdles that are typically part of bank lending.
The new Caregiver non-bank reverse mortgage, by contrast, keeps all the funds lent — and all interest accrued — inside the family. National Family lends no money itself, it provides the legal framework (documentation, recording of liens, recordkeeping, and servicing) needed to make family-funded loans legitimate financial instruments, compliant with Internal Revenue Service (IRS) and state rules.
In an intra-family loan transaction, family members — children, grandchildren, aunts, uncles — can pitch in to lend money or a single family member can take on the role as the sole lender.
4 Advantages of Intra-Family Lending
Intra-family lending has four advantages, provided the family members can pull together the necessary resources:
1. Interest rates and other terms can be far more favorable than what banks offer. The minimum interest rate must only meet or exceed the IRS’s “applicable federal rate” or AFR. Currently, the minimum AFR for “long-term” financings such as mortgages is 2.47 percent.
2. There’s no minimum age requirement for the homeowner. Traditional reverse mortgage borrowers must be 62 or older, but the Caregiver Mortgage can be done at any age.
3. Intra-family lending has no credit score requirements, debt-to-income ceilings or other hurdles that are typically part of bank lending. By contrast, the dominant commercial reverse mortgage program has begun requiring reverse mortgage applicants pass new, tougher qualification tests; has lowered maximum loan payout amounts and continues charging high insurance fees.
Similarly, home equity credit lines from banks, another popular source of cash for older Americans who want to remain in their homes, typically require a full battery of creditworthiness, financial reserves and strict loan-to-value limits as part of the qualification process.
4. The home can stay in the family. With a traditional reverse mortgage, the home must be sold or the mortgage must get paid off when the owner dies or moves. With the Caregiver Mortgage, the family members can hold onto the house.
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How a Caregiver Mortgage Might Work
What does a Caregiver reverse mortgage look like? How much money, and on what schedules, do the family lenders send to Mom and Dad? That’s entirely up to the participants, and National Family provides a helpful calculator on its website allowing prospective customers to run hypothetical scenarios.
Let’s say, for example, that Mom and Dad could use an extra $2,500 a month to supplement their income and that none of their grown kids can afford to lend out that much individually, but together they can manage to pool that amount.
So they contact National Family after deciding among themselves what interest rate to charge — say 3 percent, which is better than what this lenders-to-be are getting on their bank deposits or money market funds. The family also decides who will contribute how much — one sibling might be able to afford $500 a month, another can only spare $250 and a third can make up the $1,750 monthly balance.
Then they begin drawing up basic documents with National Family’s assistance. They spell out everybody’s obligations and their eventual proportional split of the home equity. They include contingency language for events like the inability of a family co-lender to continue making contributions or Mom and Dad’s failure to pay property taxes and insurance premiums (which is their obligation under the terms of the loan).
For its services in setting all this up and registering the intra-family reverse mortgage with local officials, National Family charges a one-time fee of $2,500.
Some Potential Downsides
Are there potential downsides for the participants in a Caregiver reverse mortgage? Definitely.
Though National Family helps draw up the documents and advises the co-leaders and borrowers, the family members must police themselves to make certain the funds keep flowing as promised. If a sibling runs into financial problems down the road, someone else in the family will have to pick up the slack.
To help deal with that possibility, consider creating an escrow account for unexpected payment interruptions, deaths, and illnesses.
There’s also the possibility that Mom and Dad live extra-long lives but their home value stagnates or declines. That could mean the co-lenders won’t get all their money back.
As with all reverse mortgages, consult a knowledgeable attorney, CPA or another financial adviser before plunging into one of these intra-family deals. That way, you’ll help ensure that you’ll be assisting your parents, not causing a family rift.