Changes to reverse mortgages affect Medicaid planning techniques
By Mike Anthony
A reverse mortgage is a loan for people ages 62 and older that lets them tap home equity. The reverse mortgage requires repayment if the homeowner dies, moves, or sells the property.
On August 9, 2013, President Obama signed the Reverse Mortgage Stabilization Act into law, empowering the Department of Housing and Urban Development (HUD) to make some significant changes to the reverse mortgage program. The changes in this law will have a direct impact on Medicaid eligibility planning.
Here is a summary of the changes and their likely effect on Medicaid planning techniques:
Financial assessments required
Traditional mortgages must undergo financial assessments to determine if the borrower is qualified to service the mortgage payments. Because a borrower doesn’t have to service a reverse mortgage, there have been no requirement that they be financially able to service a loan. The catch in this is that the patient must still be able to pay the ongoing property taxes and homeowner premiums for the hospital.
Because a large number of people couldn’t pay these payments because their income was being directed to a Medicaid co-pay, they ended up in technical default.
While final HUD regulations have not been implemented yet, it is likely they will use the borrower’s credit score to determine financial suitability for the loan. This is problematic for seniors, since many do not use credit and therefore are unconcerned with or unfamiliar with their credit score. This is also problematic for seniors who use reverse mortgages to clean up debt that might have lowered their credit score in the first place.
Anyone with poor credit scores would not necessarily be incapable of getting the reverse mortgage, but the program is likely to require the borrower to have a forced set aside of some of the proceeds so that funds will be available to pay insurance proceeds should the borrower become insolvent.
Limits on lump sums
The DRA of 2005 instituted an equity cap for homes. For those in need of Medicaid, the use of a reverse mortgage is one option listed right in the DRA to reduce home equity. That option may be limited under the new legislation.
While small lump sums will still be available, the idea of gutting a home’s equity in one fell swoop will be history. Large lump sums will be replaced with a monthly income stream, which could have disastrous effects on Medicaid patients.
Under the current program, a homeowner can lower the home equity to get below the cap or cannibalize home equity to shift it to other safer harbors. This is especially true in states where estate recovery is waiting in the wings to pick the carcass clean. But establishing a reverse mortgage with only guaranteed income payments will convert an exempt asset under Medicaid into countable income, which is the opposite of good Medicaid planning. No need to wait for estate recovery with the new-and-improved reverse mortgage. The steady guaranteed income will slowly convert home equity into nursing home co-payments. Planners will be forced to find creative ways to assign these income streams to community spouses or to secondary purchasers in order to keep the system from slowly bleeding protected equity into the cost of a patient’s care.
Community spouse safe from eviction
Even the darkest federal clouds come with a silver lining. The typical reverse mortgage has a clause that requires the property to be sold if the owner no longer lives there. When an owner goes into a nursing home for an extended length of time, these clauses can be used by the lender to sell the property.
Additionally, at death, a property is foreclosed against automatically. When a couple jointly owns the property, the presence of a community spouse in the home is sufficient to forestall foreclosure. But only if the community spouse is a joint owner on the deed.
As is the case in many instances, community spouses and widows are forced to pay off the reverse mortgage to stay in the home if the property was titled solely in the name of the patient spouse. Under the new federal rules, the community spouse/widow would not be evicted from the home under this scenario.
This will give community spouses who are not joint owners an added layer of security if there is a reverse mortgage present. Additionally, it will help forestall recovery, since a property cannot be recovered against if there is a community spouse. A forced sale could put residual home equity into a patient’s recoverable estate — especially if the community spouse is not an heir (which is often the case in second marriages).
It will often make senses to use a lump-sum reverse mortgage for a whole host of Medicaid planning reasons. If the lump-sum approach works for your client, you better get a move on. Locking in lump sum reverse mortgages before HUD publishes final rules will preserve the options that the existing system can provide your client. For future cases, knowing how the final reverse mortgage rules will impact your clients’ abilities to protect their homesteads will make you an invaluable planner.