About reverse mortgages

A reverse mortgage is a type of loan available to homeowners, typically aged 62 or older, that allows them to convert part of the equity in their home into cash. Unlike a traditional mortgage where the borrower makes monthly payments to the lender, in a reverse mortgage, the lender makes payments to the homeowner.

Here’s how it works:

  1. Eligibility: The homeowner must be at least 62 years old, own the home outright or have a significant amount of equity in it, and live in the home as their primary residence.

  2. Loan Payments: Instead of making monthly payments to pay down the loan, the homeowner receives payments, either as a lump sum, monthly payments, a line of credit, or a combination of these. The loan amount is based on factors like the home’s value, the homeowner's age, and current interest rates.

  3. Repayment: The loan is not repaid until the homeowner sells the house, moves out permanently (for example, into assisted living), or passes away. At that point, the loan (including the principal and accumulated interest) is repaid, usually through the sale of the home. If the home is sold for more than the loan balance, any remaining equity goes to the homeowner or their heirs.

  4. Non-Recourse Loan: Reverse mortgages are generally non-recourse loans, meaning the homeowner or their heirs won’t owe more than the home’s value when the loan is due, even if the loan balance exceeds the home’s sale price. The difference is covered by mortgage insurance.

Types of Reverse Mortgages:

  • Home Equity Conversion Mortgage (HECM): This is the most common type of reverse mortgage, insured by the Federal Housing Administration (FHA).
  • Proprietary Reverse Mortgages: Offered by private lenders, these are typically for higher-value homes and aren’t subject to FHA limits.
  • Single-Purpose Reverse Mortgages: These are the least expensive option but are offered by some local or state government agencies or nonprofits, and can only be used for specific purposes, such as home repairs or property taxes.

Key Features:

  • No Monthly Payments: Homeowners don’t have to make monthly payments as long as they continue to live in the home, though they are responsible for paying property taxes, insurance, and maintenance costs.
  • Loan Amount: The amount you can borrow depends on factors like the age of the youngest borrower, the value of the home, and current interest rates. The older you are and the more equity you have, the more you can borrow.

A reverse mortgage can be a useful financial tool for retirees who want to access their home’s equity without selling the home or taking on monthly mortgage payments, but it also reduces home equity over time and comes with fees and interest that can accumulate.

 

Reverse mortgages can provide financial relief for retirees but come with notable pros and cons. Here's an overview:

Pros of Reverse Mortgages:

  1. Supplemental Income: Reverse mortgages provide additional income for retirees who may have limited cash flow but have significant equity in their homes.
  2. No Monthly Payments: Borrowers don’t make monthly mortgage payments. The loan is repaid when the homeowner sells the house, moves out permanently, or passes away.
  3. Stay in Your Home: Homeowners can stay in their homes as long as they continue to pay property taxes, insurance, and maintenance costs.
  4. Flexible Payout Options: Reverse mortgages offer different payout structures, such as lump sums, monthly payments, or a line of credit.
  5. Non-Recourse Loan: The borrower or their heirs won’t owe more than the home’s value at the time of repayment, even if the loan balance exceeds the home value.

Cons of Reverse Mortgages:

  1. Reduced Home Equity: Over time, reverse mortgages decrease home equity, which could affect your estate and inheritance for heirs.
  2. Costs and Fees: Reverse mortgages typically come with higher upfront fees, including origination fees, mortgage insurance, and closing costs, which can reduce the amount of money received.
  3. Interest Accumulation: Interest is added to the loan balance each month, so the loan amount increases over time, meaning you owe more.
  4. Impact on Benefits: While Social Security and Medicare are not affected, income from a reverse mortgage could impact needs-based government benefits like Medicaid or Supplemental Security Income (SSI).
  5. Homeownership Risks: Homeowners must still cover property taxes, insurance, and maintenance. Failure to do so could result in foreclosure.
  6. Complexity: Reverse mortgages can be complicated and might not be suitable for everyone. It's crucial to fully understand the terms and consult a financial advisor.

A reverse mortgage can be beneficial in certain situations, especially if you plan to stay in your home long-term and need additional income. However, it's essential to weigh these pros and cons carefully based on your financial goals and circumstances.

Can income from a reverse mortgage increase a retiree's federal income tax bill?

No, income from a reverse mortgage does not increase a retiree’s federal income tax bill. The IRS treats reverse mortgage proceeds as loan advances, not as income, so they are not subject to federal income tax. Here’s how it works:

  • Loan Proceeds: When you take out a reverse mortgage, you’re essentially borrowing against the equity in your home. Since this is considered a loan, the amount you receive isn’t taxable as income.

  • No Impact on Taxable Income: Whether you receive the reverse mortgage proceeds as a lump sum, monthly payments, or a line of credit, it doesn't count as taxable income. This can be advantageous for retirees who are concerned about managing their income to stay in lower tax brackets.

However, it's important to keep in mind:

  • Interest Deduction: Any interest that accrues on a reverse mortgage isn't deductible on your taxes until the loan is repaid. Typically, this happens when the home is sold or the borrower passes away.

  • Impact on Other Benefits: While reverse mortgage income doesn’t affect federal taxes, it could impact eligibility for certain needs-based programs like Medicaid or Supplemental Security Income (SSI), since those programs may consider reverse mortgage proceeds as an available resource.

To summarize, reverse mortgage income will not increase your federal income tax, but it's important to consider the overall financial impact, especially concerning other benefits or estate planning strategies. Always consult a qualified financial advisor before deciding to apply for a reverse mortgage.