Reverse Annuity Mortgage - Clarifying the Term

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[tag]Reverse annuity mortgage[/tag] is a phrase with dual meanings. Most users of the term are simply referring to a basic [tag]reverse mortgage[/tag]. One of the payment options available to reverse mortgage borrowers is the tenure payment option which acts very much like an [tag]annuity[/tag]. Under this option. homeowners receive fixed monthly payments - comparable to annuity payments - for as long as they live in the home, even until death.

Here’s a typical definition found at Investorwords.com:

reverse-annuity mortgage

Definition
An arrangement in which a homeowner borrows against the equity in his/her home and receives regular monthly tax-free payments from the lender. also called reverse mortgage or home equity conversion mortgage.

But a second (and more precise) defintion of reverse annuity mortgage is found at AARP’s Glossary of Reverse Mortgage Terms:

reverse annuity mortgage - a reverse mortgage in which a lump sum is used to purchase an annuity that gives the borrower a monthly income for life.

This second use of the term refers to something much different than above. Under this scenario, the homeowner takes the reverse mortgage proceeds as a lump sum payment (as opposed to tenure payments) and purchases an insurance company annuity product.

Why would a homeowner buy an insurance annuity in lieu of taking tenure payments? There are two main reasons:

First, monthly payments under an insurance company annuity continue for life, regardless of whether the homeowner stays in the home. Senior homeowners sometimes find they must sell due to health or other reasons, even though their intent when taking out a reverse mortgage was to remain in their home the rest of their lives.
Second, many annuities can be invested in stocks and other assset categories that may produce higher monthly payments than available through a reverse mortgage.

On the other hand, monthly reverse mortgage payments will not be subject to federal income taxes whereas at least a portion of monthly annuity payments will be taxable.

So, is it a good idea to purchase an annuity product with reverse mortgage loan proceeds? It depends. Annuities are a complex financial instruments unto themselves. There are many variations - immediate annuities, deferred annuities, variable annuities, etc. - each with its own idiosyncracies and pitfalls for the unwary. In the right circumstances, a reverse annuity mortgage combination can be beneficial. But it will take a lot of homework and independent expert guidance to help a homeowner make the correct decision.

One thing that can be said with certainty is that it is never a smart idea to “bundle” a reverse mortgage transaction and annuity purchase together. A favorite tactic for reverse mortgage fraud artists has been to combine the two complex, hard-to-understand transactions in a manner that takes advantage of the senior homeowner. In some cases, abusive lenders have told seniors that the purchase of an annuity was a “requirement” for obtaining a reverse mortgage. After experiencing many such reverse annuity mortgage fraud cases, California recently enacted legislation specifically prohibiting this practice. Under the new law:

A reverse mortgage lender or a broker arranging a reverse mortgage loan shall not:

(1) Offer an annuity to the borrower prior to the closing of the reverse mortgage or before the expiration of the right of the borrower to rescind the reverse mortgage agreement.

(2) Refer the borrower to anyone for the purchase of an annuity prior to the closing of the reverse mortgage or before the expiration of the right of the borrower to rescind the reverse mortgage agreement.

Potential reverse mortgage borrowers in states other than California should follow this principal as well and strive keep the reversemortgage and annuity purchase decisions separate from one another.