Using a reverse mortgage to buy a vacation home in the Cayman Islands sounds like one of the worst uses for the federally overseen program meant to help older homeowners either fund their retirement or at least stay in their homes by no longer having a mortgage bill.
A lot of rules were changed this year for reverse mortgages, where homeowners must be 62 or older and have substantial home equity so they can get a loan that is repaid when they move or die. The new rules were meant to protect borrowers from themselves, preventing them from taking out too much home equity, lowering the maximum loan amounts, and making sure they can afford property taxes, insurance and other costs of home ownership, among other changes.
Buying a vacation home
However, the new rules haven't eliminated one of the more unusual uses for a reverse mortgage and that's to buy a new home entirely. For example, it's possible to use the proceeds from a reverse mortgage to buy a vacation property or second home, as there are no restrictions on how you use the funds. In another twist, in some cases you can even use a reverse mortgage to buy a new primary residence and not have to make monthly mortgage payments.
Here are a couple example of how they work.
Clients of Sean McGeehan, a mortgage loan officer in Homer Glen, Ill., cashed out about $200,000 with a reverse mortgage on their home in Illinois that they owned free and clear so they could pay cash for a vacation home in the Cayman Islands, McGeehan says.
The couple, in their early 70s, had been vacationing there for 10 years and always wanted to buy a home there, figuring it was cheaper than renting for a month or so every year, he says. Also, financing a home purchase in the Cayman Islands is difficult if the buyer doesn't live there, so getting a traditional mortgage was out of the question, he says.
"They just wanted to be able to use their money now and enjoy it, and not let it sit in their house" McGeehan says.
They now live in the Caymans during the winter and spend the rest of the year in Illinois with their grandchildren, making sure they don't spend more than six months overseas so that the Caymans house isn't considered their permanent home. Reverse mortgage rules require that the house with the reverse mortgage loan be the primary residence of the borrower.
Using a reverse mortgage to buy a vacation home isn't a good idea if you're financially unstable. If you can barely afford to live in your current home, then buying a second home can obviously become a problem. The Illinois homeowner who bought in the Caymans had a pension and didn't worry about his assets, McGeehan says, and he didn't owe money on his house.
Most people use reverse mortgages to help pay living expenses because they're broke, McGeehan says. Another popular use is for long-term care insurance.
"It starts with just having money in the bank and having security and peace of mind," and then it's used for daily expenses and health insurance, he says.
Downsizing with a reverse mortgage
Another option for reverse mortgages is to downsize to a smaller home or condo. An older couple with a large house that their children have moved out of can sell their home, use 30-40 percent of their equity as a down payment, and get a reverse mortgage on the smaller home, McGeehan says.
Or a reverse mortgage can be a way to get out of a large mortgage you can't afford, says Linda Sands, branch manager at Luxury Mortgage Corp. in Long Island, N.Y. One of Sands' clients is a couple -- the husband is 80 and the wife is 78 -- who bought a home for $1.2 million and want to sell it because they can't afford it anymore.
Their plan is to sell the house and buy a $250,000 condo with $98,000 down and use a reverse mortgage to fund the rest, Sands says. They may be using the reverse mortgage with no intention of paying down what is owed, but the loan will have to be repaid when the owner moves, dies or if the house is foreclosed on, she says.
"It's going to be paid off in the future, one way or another," Sands says.
Either their heirs or their estate will pay it off, or if they owe more than the home is worth, the mortgage insurance will pay off the note.
The man doesn't qualify for a traditional mortgage, and is underwater on his current house and close to being foreclosed on, she says. He also has poor credit, is self-employed and wouldn't be able to make this move without a reverse mortgage as an option, she says.
"What else would these people do?" Sands asks. "They can't move in with family."
Sands says that a big thing with a reverse mortgage is you have to know that you can afford to keep the house. That includes paying property taxes, doing regular maintenance, and paying homeowners' insurance.
Workers from the Federal Housing Administration may drive by and check out your house, for example, if they have a reason to think the property isn't being maintained properly, according to McGeehan. The city government may fine a homeowner for not having their lawn mowed, and that complaint could get back to the lender.