If you’re debating a reverse mortgage to free up money, this article may help. With inflation on the rise and medical care costs escalating, you may wonder what options are available for seniors to keep up with rising costs? Especially if they have a home mortgage and their retirement income is fixed. Often a fixed income barely covers the mortgage payments and other necessities, with little left over for enjoying retirement.
One choice may be a reverse mortgage. This process allows the homeowner(s) to borrow against the equity they have built up in their home over the years. The loan is not due until the homeowner passes away or moves out of the home. If the homeowner dies, then the homeowner’s heirs can pay off the debt by selling the house. And any remaining equity goes to the heirs. If the loan balance at that time is equal to or more than the home’s value, then the repayment amount is limited to the home’s worth. Generally, the reverse mortgage won’t be due as long as at least one homeowner lives in the home as their primary home.
Reverse Mortgage Eligibility
In order to be eligible for a reverse mortgage, the borrower must be at least 62 years of age and have equity in the home. The reverse mortgage must be a first trust deed. Thus, any existing loans would have to be paid off with separate funds or with the proceeds from the reverse mortgage. The amount that can be borrowed is based on the borrower’s age, current interest rates, appraised value of the home, and government-imposed lending limits. The older the borrower, the greater the amount that can be borrowed and the lower the interest rate.
The borrower can take the loan as a lump sum, as a line of credit, or in equal monthly payments for a fixed number of years or for as long as the borrower lives in the home. In addition, the money generally can be used for any purpose, without restrictions. As is the case with other loans, the reverse mortgage loan is not taxable, regardless of the payment method. The borrower retains the title to the home and must continue to pay property taxes and homeowner insurance as well as maintain the property. Thus, property taxes – within the $10,000 annual SALT limitation – that the borrower pays will continue to be tax deductible if the borrower itemizes deductions.
Do Reverse Mortgages Have Deductible Interest?
One question that always comes up when discussing reverse mortgages is whether the interest will be deductible. Consider the following factors when determining whether reverse mortgage interest is deductible, when it is deductible, and by whom:
- Interest (regardless of type) is not deductible until paid. A reverse mortgage loan does not need to be repaid as long as the borrower lives in the home. Therefore, the interest on a reverse mortgage is not deductible by anyone until the loan is paid off.
- Generally, reverse mortgages are classified as equity loans. Under the 2017 tax-reform rules of the Tax Cuts and Jobs Act (TCJA), equity debt interest is not deductible during the years 2018 through 2025.
Reverse Mortgage Exceptions
There are exceptions for when the reverse mortgage is used to pay off an existing acquisition debt loan. If the reverse mortgage was used to refinance an existing home-acquisition loan, then when the reverse mortgage loan is paid off, a prorated portion of the accrued interest will be deductible home-acquisition debt interest.
The mortgage interest deduction is limited to what would have been deductible each year if the borrower had paid it and accrues until the loan is paid off, at which time it is deductible.
Who Deducts the Interest of a Reverse Mortgage When the Loan is Paid Off?
Borrower
If the borrower pays off the loan while still living, then the borrower can deduct the sum of the interest he or she would have been entitled to deduct each year had it been paid, subject to the limitations discussed in 1 and 2 above.
Estate
If the estate pays off the mortgage after the borrower has passed away, then the estate would deduct the interest on its income tax return. The deductible amount would be the sum of the interest that the borrower would have been entitled to deduct each year had he or she paid it, subject to the limitations discussed in 1 and 2 above.
Beneficiary
If the beneficiaries who inherit the home pay off the mortgage, then they would be able to deduct the interest as an itemized deduction on their personal 1040 income tax returns. The deductible amount is the sum of the interest the borrower would have been entitled to deduct each year had he or she paid it. This is subject to the limitations discussed in 1 and 2 above.
Reverse mortgages have brought financial security to many seniors so that they can live a comfortable life. Keep in mind, however, that some reverse mortgages may be more expensive than traditional home loans. Also upfront costs can be high, especially if you don’t plan to be in your home for a long time. And reverse mortgages aren’t the best solution if you only need to borrow a small amount.
Comparison between reverse mortgages and home equity loans:
| Issue | Home Equity Loan | Reverse Mortgage |
| Uses equity in the home as collateral | Yes | Yes |
| Who can apply? | Any homeowner | Homeowners aged 62 or older |
| Repayment period | Typically, monthly for 5 to 10 years | None, until the borrower dies or moves out of the home |
| Effect of closing costs on interest rate | If no costs are charged, the interest rate is usually higher | Paid upfront but generally lower interest over the loan period |
| Requires borrower-paid counseling | No | Yes |
| Credit score required | Yes | Generally, no |
Before taking out a reverse mortgage, you should carefully consider all of your options. Alternatives to reverse mortgages could include selling the home or taking out a conventional mortgage. Other options could be to take in room renters, or renting out the home while living elsewhere. Consider discussing all the options with your family members before taking action. Questions about how a reverse mortgage might affect your tax situation? Please give this office a call.
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