By their very nature, reverse mortgages are designed to remain outstanding until the death of the last remaining borrower. This raises a couple important questions: how is this debt repaid, and what obligations, if any, are assumed by the borrowers’ heirs?

Reverse mortgage lenders certainly don’t make this issue easy to understand, since some claim that the debt is transferred to the borrowers’ heirs upon death, but others advertise that the slate is wiped clean and hence, there is no risk that the heirs would be on the hook for any unpaid debt. As it turns out, they are both right.

Since a reverse mortgage is a loan agreement, of course it must be repaid. In most cases, the property that serves as collateral for the reverse mortgage is simply sold upon the death of the borrower, and the proceeds from the sale are used to repay the loan. Any leftover cash reverts to the borrower’s estate and will be distributed accordingly. If the sale of the property does not generate enough proceeds to repay the loan, the FHA – assuming the reverse mortgage was a Home Equity Conversion Mortgage (HECM) – is on the hook for the difference – not the borrower and certainly not his estate. It is because of this FHA insurance, that neither the borrower nor his heirs bear an risk from property depreciation (unlike with a conventional mortgage) when obtaining a reverse mortgage. [If the reverse mortgage was an insured private loan, the above doesn’t apply].

The problem of repaying the loan naturally becomes more complex if the borrower’s heirs (or the borrower himself, if the reverse mortgage was called while he was still alive) wish to keep the property, rather than selling it to repay the loan. In this case, it is incumbent upon them to generate cash from other sources (savings, investments, or conventional mortgage). Typically, there is a 12-month grace period afforded by the lender during which time the borrower and his heirs must sort out the repayment of the loan. During this time, the reverse mortgage remains outstanding and will continue to accrue interest.

When viewed from this perspective, it’s easy to see how the borrowers’ heirs could become responsible for repaying the reverse mortgage. Still, I think the distinction between voluntarily repaying the loan (due to a desire to keep the property) and assuming a legal obligation to do so.