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November 15, 2007
HOUSE RICH, CASH POOR
Even though the real estate market is down a little bit, if you have owned your home for long enough, it’s probably worth a lot more than what you paid for it. Unfortunately, maintaining a home while on a fixed income can drain your cash flow. Here is a way to keep your home, improve your cash flow and provide an inheritance to your children.
EXAMPLE: “Sarah” is 75 years old and a widow. Her home is valued at $350,000. Her monthly social security benefit is $1,100. The problem is, that there are many home repairs that are long overdue. “Sarah’s” house needs a new roof, windows, and a new heating system. “Sarah” doesn’t want to move.
A possible solution for “Sarah” might be to get a reverse mortgage. A reverse mortgage could give “Sarah” up to about $220,000, but she estimates that she will only need about $150,000 to make the necessary repairs, and these repairs will help reduce her heating bills considerably.
The next step that “Sarah” takes, is to protect her remaining equity in her home for her children. She transfers her home to her children, while retaining the right to live in the property for the rest of her life. This is called a life estate.
Let’s move 5 years into the future now. “Sarah” is now 80 years old and unfortunately, is in need of nursing home care. Her home is sold, and because she created a Life Estate, the actuarial tables tell us that she is to receive 43.659% of the sales proceeds or, $152,806 (sales price $350,000 x 43.659% = $152,806). “Sarah” must now pay off her reverse mortgage of $150,000, leaving her with a net of $2,806. Once she has reduced her assets to below $2,000, she will be eligible for MassHealth (Medicaid in Massachusetts). Her children, known as the remaindermen, will receive the balance of $197,194.
This case results with a win, win situation. “Sarah” was able to accomplish her goals of staying in her home and preserving some of her assets for her children. If Sarah had not created the life estate after getting the reverse mortgage, she would have received the $197,194, and not her children. With nursing home costs running at about $10,000 per month, it would not take too long before it was all gone.
Other Financial Considerations - Reverse mortgages, as compared to conventional mortgages, cost a lot. The upfront closing costs can range from about $8,500 to over $16,000. That’s a lot of money! But on the flip side, you might sleep much better knowing that you will never have to make a mortgage payment on a reverse mortgage. Another small annoyance with the above plan is that your kids will have to pay about 20% in taxes on the amount they receive. These taxes could be eliminated by the use of an irrevocable trust as a remainder beneficiary, instead of the children. With the trust, the children would have to wait until “Sarah’s” death before collecting their share.
Before anyone can get a reverse mortgage, a counseling session is necessary. There are about a handful of counseling centers in Massachusetts and their job is to ensure that you understand what you are getting into and that it is appropriate for your particular situation.
This article gives general information and not specific advice on individual matters. Persons wanting individualized advice on matters discussed should contact an advisor experienced in those matters. To the extent this article provides information on legal matters, it is based on law in effect in Massachusetts on the date of posting (laws in effect in other states are often quite different).
Ronald H. Surabian is a CPA and attorney who works at the Elder Law Center in Saugus, Massachusetts. He also holds Masters in accounting and a Masters in tax law. He currently serves on the board of directors of the Massachusetts Chapter of the National Academy of Elder Law Attorneys. If you have any questions please call me at the Elder Law Center, One Essex Street, Saugus, MA 01906 (781)233-4444. To view this or any prior article, please visit our web site at www.elderlawcenter.org