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Reverse Mortgage: An OFW’s Estate Planning Tool

(Article published in the Apr 5, 2006 issue of Manila Standard Today)

Mr. Joey Cuisia, PhilAm Life’s top man, was reported to have recently observed (with a tinge of complaint) that real estate salesmen, targeting our workers abroad, have entered in a big way the local insurance industry’s once exclusive turf. Property developers have been sending armies of sales agents to countries with great concentration of Filipino overseas workers to push the sale of their real estate projects in the Philippines. The agents’ success has accounted for, many say, the recently appreciable increase in sales in the local property market, particularly residences, known as "the OFW phenomenon". The real estate industry has indeed given the insurance industry, in a manner of speaking, a run for its money.

From an OFW’s perspective, however, acquisition of real estate, is primarily a method of storing the value that he earns abroad. While he is overseas and earning, the value remains stored, perchance to increase, often to be used by kin. But the time comes when sense and sinew begin to tire, and his heart begins to hear the call of his mother’s lullaby from home.

When the OFW comes home, after relatives have emptied his balikbayan boxes of pasalubongs, how does he unlock the value that he had prudently stored in real estate?

Reverse mortgage is a financial product that our banks and financial institutions ought to think of making available to him.

This advocacy for the adoption of reverse mortgages in our country, I must credit to Leia Castañeda, daughter of Lulu Tesoro. Mother and daughter, both mentioned here by the maiden names I first knew them, were at different times my students at the Ateneo Law School and both were at the top of their respective batches. Leia now confirms, as do others abroad whom I consulted, that reverse mortgages are the "in-thing" in the US of A, undoubtedly driven by the now aging "baby boomers" waking up to the fact that the Bush administration may not be able to deliver their pensions in the amounts they thought forthcoming.

Official figures say that Americans took out, during the federal fiscal year of 01 October 2004 to 30 September 2005, about 43,000 reverse mortgages. Four years ago, for the same period, only about 7,700 were written. Surely, what this financial product can do for our returning heroes is worth thinking about.

"Reverse mortgage", like others terms such as "Living Trust" that were conceived in Washington by lawyers and reared in Wall Street by finance men, is the child of a grammatically meretricious coupling of an adjective to a noun it does not modify. In reality, there is nothing backwards in reverse mortgages; in fact, it is forward-looking.

A property owner takes out a mortgage on his residential property. Under the kind of home mortgage we are familiar with, the lender-mortgagee gives the borrower-mortgagor a lump sum and the latter starts repaying the loan as per stipulated schedule in installments over several yerar. In a reverse mortgage, the mortgagor usually gets the principal cash in installments over a period of years, and the total loan must be repaid only when the property owner ceases to use it as his home by selling it or leaving it for good, like dying. In the meantime, he has ordinarily no obligation except the payment of taxes and maintenance of the property in good habitable condition.

Hence, the legal arrangement is still very much like the home mortgage that we know. It is essentially a loan secured by a mortgage on the home. What is "reverse" is simply the trickling cash-flow. In a conventional mortgage, the cash trickles go over the years from the borrower in the direction of the lender; in a reverse mortgage, the cash periodically trickles from the lender towards the borrower. But since payment of the principal is to come only when the property ceases to be the residence of the borrower, what he, in effect, is able to do in a reverse mortgage is to unlock and withdraw the value of his real estate capital through the gradual receipt of its equivalent from a willing lender who recovers his cash-out on the principal upon sale of the property. For that reason, what the Americans call "reverse mortgage" is known by their less glitzy cousins by the English Channel more straightforwardly as "capital withdrawal."

The reverse mortgage’s innovation, or unique characteristic as far as our traditional understanding of home mortgages is concerned, is the feature that the principal is not due until the departure of the borrower from life or from the residence. In that case, the property mortgage must be sold and the proceeds are used to pay off the principal obligation. The excess, if any, goes to the borrower or his heirs; the deficiency, if I am not mistaken, is shouldered by the lender. This requires, undoubtedly, determined public policy to ensure a reasonable liquidity in the residential market. A challenge, but certainly not something that Noli De Castro and/or PAG-IBIG cannot meet.

How the "principal in installments" is used by the borrower is unrestricted. Hence, the borrower may use it to supplement his pension, or save up for special occasions, or assure the payment of the tuition and other school expenses of a late child. He may even decide to match them with the installment price of another real estate he wants to buy. In the latter case, a home owner can take a reverse mortgage on his home in the city to buy in installments a property in his hometown and pocket the difference. The uses for lifetime estate planning of a reverse mortgage are thus limitless.

And when combined with other tools of estate planning, reverse mortgage opens possibilities for saving on estate taxes due on the property. Let me just mention one. A reverse mortgage can be taken out to fund the yearly premiums on an irrevocable life insurance in favor of his children that the owner takes out in his own life for the purpose of funding their payment for his estate taxes. The result is that the value of the residence to be reported as part of the gross estate is reduced by the amount of the capital withdrawn. The proceeds which were paid for by the capital withdrawn are also tax-free. At the very least, the arrangement results in removing from the estate tax base, the amount of money paid as estate taxes.

In a later column, I will demonstrate in greater detail the mechanics and the specific advantages of this and other estate planning techniques that can be used in conjunction with reverse mortgages. In the meantime, I think Joey Cuisia ought not complain too much. OFWs buying real estate is part of his market, too. And the OFW phenomenon is not all that bad for his industry.