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What’s Wrong With Reverse Mortgages?

It sounds like a great idea! Tap the equity in your home when you are older and on a fixed income. Pay down your bills. Use the money to travel. What could go wrong?JohnMenszer-1050158

A lot.

1) “You can stay in your home as long as you live.” If you live with another person who is not listed on the reverse mortgage, when you die they will not be allowed to remain in the home. This is true even if they are on the deed. Why would they not be listed on the reverse mortgage? The amount of equity you can take out of your home depends on the age and credit worthiness of the borrowers. It may have made financial sense to leave the younger, less creditworthy person off of the reverse mortgage.

2) “Your up front costs are minimal.” Actually, the fees, commissions and costs of a reverse mortgage are high. But because they are deducted from the loan proceeds at closing and financed by the mortgage, you may not be aware of them. And note, the interest rates on most reverse mortgages are variable.

3) “Everything is taken care of.” Some reverse mortgages provide for the payment of taxes and insurance. If not, this will be your responsibility. If you don’t pay them, you will be in default of your contract. Also, you home has to be maintained properly. You will be responsible for repairs and upkeep. You can be placed in default if you fail to maintain your property.

4) “After you die your heirs can make arrangements to keep the property.” Your heirs will have six months to payout the loan or turnover the property. This is not much time. Let’s say the value of your home increased and exceeds the payoff of the reverse mortgage. This is wealth that should benefit your heirs. But to profit by it they will have to either find financing to payoff the reverse mortgage or sell the property to someone else. Do you want to leave your heirs with this problem? (Note: The six months can be extended by up to two 90-day extensions.)

Consider this real life example.  Mr. X (the names have been concealed to protect the innocent and the guilty) took out a reverse mortgage on his home on October 18, 2010.  He could use the $5,000.00 in ready money and established a line of credit he could draw upon to do improvements to his home.  At the closing the Bank got a fee of $3,510.00, HUD got $3,430.00 for mortgage insurance, there were other costs for a total loan amount of $17,859.26.

Mr. X died 8 days later.  His sole heir was a minor.  His heir should have paid off the loan at that point which would have cost $17,859.26, plus interest.  But, where to get the money?  There was only the $5,000.00 left from the loan closing.  Nothing was done.  Of course, the line of credit could not be drawn upon.

Fast forward to 2015.  The property was vandalized and stood vacant.  The lender finally was foreclosing.  The amount owed, due to interest and costs, was now $57,311.00.  The home is not worth much more than that now.  What a waste!

 

 

Should I be afraid of Zombie Real Estate?

JohnMenszer-0690It happens so often. I ask clients if they own a home and they say, “No, but I am buying one from the bank.” There is a popular misconception that when you are paying a mortgage, you don’t own the property until it is fully paid for. In fact, when you buy a piece of real estate on credit you are owner from the time the ink dries on the paper.

The three essential documents involved in a credit purchase of real estate are: the Act of Transfer, the Note and the Mortgage. The Transfer, also known as the Deed, transfers ownership from the seller to the purchaser. The Note is a statement of the amount the purchaser owes and the terms of repayment. The Mortgage is a security agreement that ties the note to the real estate, giving the lender certain rights over the property. Among those rights is the option to foreclose if the Note becomes delinquent.

Notice, I said “option to foreclose” because here is where the Zombie Real Estate comes in. There are unknown numbers of these foreclosure horrors where it is the bank’s refusal to foreclose which sets the owner down the path to perdition. Zombie Real Estate is property that nobody wants which keeps racking up costs for the owner.

I read of a property owner in Ohio who fell behind to JP Morgan Chase due to ill health. He received a foreclosure suit and proactively moved out before the date of the sheriff sale to live with his daughter. Then the bank quietly dropped the suit. Two years later he started getting bills for taxes, waste removal, weed control, and was threatened with demolition costs.

In depressed markets banks are walking away from properties. If they foreclose they have the legal costs and the expense of keeping up the real estate owned (known in the trade as “REO’s). In not foreclosing the bank can reap accounting and tax benefits from the government and sell the debt at a deep discount to debt collectors, who then hound the owners.

In my practice I once had a case of Zombie Real Estate in a bankruptcy. A client had a piece of investment real estate that he wanted to give back to the lender, as well as a lot of hospital bills and other debts that justified filing a Chapter 7. We filed his case and listed his intention to surrender this property to the bank. Unfortunately, before the lender could foreclose the property was damaged and the lender decided not to foreclose after all. The wrecked property sat for years with the City racking up liens and charges. The Note on the property was discharged in the bankruptcy, but since the City’s liens and charges dated from after the bankruptcy they were fresh obligations to the debtor.

You can’t force a bank to foreclose if it doesn’t want to and you can’t make them accept a donation, a dation or a quitclaim, unless they sign the document. What you own may not be so easy to get rid of.