Reverse Mortgages: My Children Want to Buy My Home, But It’s “Under Water”?

Real estate has done some fascinating things in my lifetime.  The price of homes has really gone up, interest rates have been everywhere (double digits when I bought my first house and now they are as low as ever), and everything in between.  

I’ve been considering a reverse mortgage for some time now.  I’m 65, retired, and own my home outright.  A reverse mortgage would be appealing to me because it would allow me to leverage the equity I have in my home to receive payments from the bank.  This could provide some supplemental cash to meet some needs during retirement.

One situation I’ve been thinking about is what happens if my home is “under water” but my children want to buy it?  Said another way, the amount of the loan is greater than the value of my house when the loan becomes due and payable.

A quick review of a reverse mortgage and how it becomes due and payable…A reverse mortgage is a loan, and it becomes due and payable when the last homeowner passes away.  It could also happen if a home owner decides to sell their house (but there is no advantage to doing this if the home is worth less than the balance of the reverse mortgage loan).  Also, a reverse mortgage is a non-recourse loan, and this means that when I pass away, my children can never owe more than the value of my home.  To read a bit more on what a non-recourse loan means, click here.

When the last homeowner passes away, the homeowner’s heirs (children in my case) have a few options:

1. Sell the home - this option is most desirable if the home is worth more than the loan amount.  This means that my children could sell the house, repay the reverse mortgage balance, and keep what’s left.  This is not really applicable for today’s blog post, but it’s important to know that this is an option if you find yourself in this situation
2. Keep the home - my children would need to repay the balance of the loan with available cash or refinance
3. Do nothing and walk away - the bank would be responsible for selling the home to repay the loan.  They are covered by insurance through FHA if they take a loss

Scenario #2 is most relevant to this situation: the balance of the loan is greater than the value of the home, and my children want to keep the house in the family.  Based on the rules for a reverse mortgage, my children would be responsible for repaying 95% of the value of the house when the loan becomes due and payable or the loan amount, whichever is less.  If the market dynamics and loan amount create a situation where the home is worth less than the amount of the loan, this rule would come into play.

If we think about an example, if my home is worth $500,000 but the balance of the loan is $650,000, my children would be able to purchase the home for 95% of $500,000, or $475,000.  

Keep in mind that this blog post specifically applies if my children want to purchase the home.  If they don’t want to purchase the home, and the loan amount is greater than the value of the home, they also have the option to walk away and let the bank sell the house to repay the loan. The bank cannot come after my children to repay any difference between the loan amount and sale price of the house.

Hopefully this provided some clarity on a very specific situation.  I’ve found that it’s helpful to think through every scenario possible so that I can make the best decision for me.  I hope this has helped do the same for you.