What options do seniors have for keeping up with inflation on the rise and medical care costs escalating—especially if they have a mortgage on their home and their retirement income is barely covering their mortgage payments and other necessities? With a small amount of income leftover for some enjoyment in their golden years, how do seniors keep up with costs without relying on help from family?
One choice may be a reverse mortgage, which would allow 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 passes away, then the homeowner’s heirs can pay off the debt by selling the house, and any remaining equity goes to them. 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.
To be eligible for this loan, 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, 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 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, homeowner’s insurance, and maintain the property. Thus, property taxes—within the $10,000 annual SALT (state and local taxes) limitation—that the borrower pays will continue to be tax deductible if the borrower itemizes deductions.
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, and 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. (In years before 2018, the deductible equity debt interest was limited to the interest accrued on the first $100,000 of debt, and equity debt interest was not deductible by taxpayers subject to the alternative minimum tax.)
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.
So, who deducts the interest when the loan is paid off?
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.
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.
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 would be the sum of the interest 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.
Reverse mortgages have brought financial security to many seniors so they can live a comfortable life. If you are a senior who is struggling with your finances, then carefully explore your options, including the possibility of a reverse mortgage. Keep in mind, however, some reverse mortgages may be more expensive than traditional home loans, and the upfront costs can be high, especially if you don’t plan to be in your home for a long time or only need to borrow a small amount. Here’s a comparison between some aspects of reverse mortgages and home equity loans:
Home Equity Loan
Uses equity in the home as collateral
Who can apply?
Homeowners aged 62 or older
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
Credit score required
Before taking out a reverse mortgage, carefully consider all of your options, such as selling the home, taking out a conventional mortgage, taking in room renters, and renting out the home while living elsewhere. This may also be something you will want to discuss with family members. If you need assistance or have questions about how a reverse mortgage might affect your tax situation, please give this office a call.