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Using Life Insurance Policy to repay reverse mortgage

HECM Reverse Mortgage

Sep 24

Using a term life insurance policy to repay a reverse mortgage…

Some potential reverse mortgage candidates do not like the idea of having their homes sold to repay the loans. There may be several reasons why homeowners want the option of keeping their homes in their families after they move out or pass away, but the most common are:

  • They have children who want to keep the home in the family.
  • They have a spouse who was not included on the reverse mortgage loan because the spouse was too young at the time. The younger spouse is considered an Eligible Non-Borrowing spouse. Recent changes in reverse mortgage regulations allow these spouses to remain in the home if the borrowing spouse passes away first. However, non-borrower spouses will not have access to any remaining loan funds after the borrowing spouse has died. At the same time, interest will continue to accrue on the unpaid balance until the loan is repaid.
  • They have remarried since obtaining the reverse mortgage and want their new spouse to be able to stay in the home if they pass away first.

The protection given to Eligible Non-Borrowing spouses only applies if the borrower and spouse were legally married at the time the reverse mortgage was obtained or in a same-sex relationship that wasn’t recognized by their state of residence at the time they entered the contract. There is nothing in the rules for reverse mortgages that addresses a marriage that occurred after the reverse mortgage started. Therefore, in this situation, the reverse mortgage must be repaid shortly after the borrower’s death. If the surviving spouse who married the borrower after the contract closed doesn’t have the funds to repay the loan, he or she will have to move and sell the property.

Repaying a loan using term life insurance

For each of the above situations, a potential option is for the borrowing homeowner to obtain a term life insurance policy. The policy could potentially provide the funds needed by the homeowner’s heirs or surviving spouse to repay the reverse mortgage without having to sell the property.

To determine if this is a viable option, the first step is to estimate how much you will borrow from a reverse mortgage. You can use a reverse mortgage calculator that will determine your maximum principal amount based on your age, the equity in your home and current interest rates.

You should then calculate the amortization on a reverse mortgage loan. This will give you an estimate of how much you will have to repay, factoring principal, interest, and fees, for a given period. Run a few scenarios based on your anticipated life expectancy.

With an estimate of how much you would potentially owe, you can then research term life insurance quotes to see how much a policy would cost with a death benefit large enough to repay the reverse mortgage. The number of years on the term policy should be at least equal to the years on the reverse mortgage amortization.

Is it financially feasible?

The key to making this strategy work is to find a life insurance policy with a premium low enough that you still have a considerable amount of your reverse mortgage monthly payment left over. It would defeat the purpose of getting a reverse mortgage if you spent most of your monthly payment on a life insurance policy designed to repay the loan.

Here’s one hypothetical example: A 65-year-old with a $300,000 home and no current mortgage balance could receive a tenure payment of around $800 a month for as long as the reverse mortgage remains active. Assuming a 4.5 percent average interest rate, the homeowner would owe about $315,000 after 20 years.

The same 65-year-old, assuming he is in good health and doesn’t use tobacco, could buy a 20-year term life insurance policy with a death benefit of $325,000 for a monthly premium of around $325. That would leave $475 a month in income from the reverse mortgage left over after paying the monthly insurance premium.

The potential downsides

This strategy won’t work for everybody. For starters, if you have poor health, a life insurance policy will be much more expensive and may not be worth it. Also, the older you are, the more expensive a policy will cost. Plus, depending on your age, you may not be able to find a term policy that will cover your life for more than 10 or 15 years.

One risk of this strategy is that you outlive your term policy. If you buy a 20-year term policy, but live beyond the term, you will have essentially spent hundreds of dollars a month in an attempt to avoid selling your home and still likely have to anyway. While there are whole life and other permanent life insurance policies that don’t expire, they are also more expensive and will use considerably more of your reverse mortgage proceeds.

The life insurance policy also won’t help you repay the reverse mortgage if you have to move out of your home due to health reasons. If that happens, the loan becomes due, in which case you will have to tap another source of funds or sell the home to repay the loan. The same will occur if you default on the loan by failing to pay your property taxes or homeowners insurance.