A reverse mortgage is a loan where the lender pays a homeowner (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while he or she continues to live in the home. With a reverse mortgage, the homeowner retains title to the home.
Depending on the plan, a reverse mortgage becomes due with interest when the homeowner moves, sells the home, reaches the end of a pre-selected loan period, or dies. Because reverse mortgages are considered loan advances and not income, the amount received is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until the loan is paid in full. The deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt. A lender commits itself to a principal amount, not to exceed 80 percent of the property’s appraised value.
Planning Point: Although available through the private sector the vast majority of reverse mortgage borrowers choose to use a Home Equity Conversion Mortgage (HECM), which are regulated by the Department of Housing and Urban Development (HUD) and only available through an approved Federal House Administration (FHA) lender.
1. How much money can a person expect to receive from a reverse mortgage?
Generally speaking, the higher the property value, the older the borrower(s), and the lower the current interest rates – the larger the loan. Although it is possible to find slight differences from lender to lender, most adhere to the four variables considered when calculating the maximum amount of a HECM Standard or HECM SAVER loan. These variables often include:
- The age of the borrower, or the youngest age of joint borrowers.
- The prevailing interest rates in the marketplace in which the loan is being written.
- The lesser of the appraised value or the maximum loan limit (presently set by HECM/FHA at $625,500) or the sales price of the home being purchased.
- The initial Mortgage Insurance Premium.
Unlike traditional mortgages where the loan to value (LTV) ratio is a significant feature, in a reverse mortgage there is no stated maximum. Unfortunately there is a general misunderstanding that the LTV ratio for a reverse mortgage is linked to the age of the borrower, leading many borrowers to believe that a 67-year-old would have an LTV ratio of 67 percent, a 70-year-old 70 percent, etc. In reality, the range for most LTV ratios is 50 to 65 percent of the home’s appraised value.
Planning Point: Another option available on reverse mortgages issued through the HECM/FHA for homeowners with appraised home values in excess of $625,500 is the private sector. Those who choose this route should keep in mind the private lenders are not required to follow the strict letter of the law as set by HUD and administered by the FHA. They should however insist that the general outlines of the HECM be followed as closely as possible.
2. How are the funds generated from a reverse mortgage distributed to the borrower?
Although some private lenders may offer different plans, generally there are five ways that a borrower can receive money:
- Lifetime or Tenure: This plan offers equal monthly payments which will be paid as long as the borrower(s) are alive and continue to occupy the property as a principal residence.
- Period Certain or Term: This plan offers the borrower(s) equal monthly payments that will be paid over a predetermined fixed period of months. The time period and payment amount is set prior to the first payment and cannot be changed. If the borrower(s) die before the end of the period, the payments will continue for the remaining period to their identified beneficiary or beneficiaries.
- Line of Credit: This plan provides for the establishment of an account that makes a predetermined amount of money accessible to the borrower at any time up until such time as the line of credit is exhausted.
- Combo or Modified Tenure: This is a combination of line of credit and scheduled monthly, or a single lump sum payment with the remainder of the funds being distributed in predetermined payments or as a line of credit.
- Combo Modified Term: This plan is a combination of a line of credit plus monthly payments for a fixed period of months selected by the borrower.
The availability of these options may vary depending on the lender.
3. Are the proceeds received from a reverse mortgage taxable?
The IRS considers a reverse mortgage a loan, and because funds received by way of a loan are not considered income, the amount(s) the borrower(s) receive at any given time are not taxable.
4. Is a Reverse Mortgage borrower required to purchase Mortgage Insurance Premium?
Yes. Mortgage insurance has always been required on HECM loans. In order to reduce the high initial upfront cost that was keeping many people over 62 from obtaining a reverse mortgage, in 2010 the Federal Housing Administration introduced the HECM SAVER. The goal was to make reverse mortgages more affordable for more seniors by reducing the initial MIP and other upfront fees. In order to do this, these cost reductions are offset by lowering the amount available to the borrower.
|(MIP) Mortgage Insurance Premium||HECM SAVER||HECM STANDARD|
|Amount of initial premium||0.01% of maximum claim amount (lesser of sales price, appraised value or FHA mortgage limit.||2% of the FHA maximum claim amount.|
|Amount of money available to borrower||Lower||Higher|
As to the deductibility of Mortgage Insurance Premiums; according to IRS Publication 936, you can treat amounts paid for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt, and the insurance contract must have been issued after 2006.
Qualified mortgage insurance. Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006).
(Excerpted from Tax Facts)