Reverse Mortgages Today
The original reverse mortgage started out as a creative instrument with noble intentions. As with all innovations however, the market saw an opportunity to make money and quickly created offerinngs that were sadly lacking in Federal scrutiny.
Today's instruments exist in a far more regulated environment and should offer homeowners more protection.
Individuals who are unwilling or unable to sell their home and need additional income during retirement may benefit from a reverse mortgage. Payments received on a reverse mortgage are not taxable to the individual. Here are some features of this financial planning tool.
A reverse mortgage can be used to generate tax-free income. Convert the equity built up inside your home into cash without having to sell the home and move. See Example #1, later.
Eliminate mortgage payments
A reverse mortgage can be used to pay off an existing mortgage, thereby creating a need for less income. See Example #2, later. This may benefit an individual who is considering retirement but does not currently have enough money on which to retire.
To qualify for a reverse mortgage, a homeowner must:
- Be 62 years of age or older,
- Own the property outright or have a small mortgage balance,
- Occupy the property as his or her principal residence, and
- Not be delinquent on any federal debt if it is a federally insured reverse mortgage.
The loan is a nonrecourse debt. The homeowner retains title to the home.
To qualify, a property must meet all FHA property standards and flood requirements. The following property types are eligible.
- Single-family homes
- Multiple-unit home of 1 to 4 units, with the eligible unit being occupied by the borrower
- HUD-approved condominium
- Manufactured home that meets FHA requirements
The income, lump-sum payout, or line of credit available to the borrower is not taxable to the borrower.
No repayment of the reverse mortgage is needed as long as the property is the borrower’s principal residence and the obligations of the mortgage are met.
Closing costs may be financed in the mortgage.
Example #1: Louise, a single taxpayer age 64, owns her home. Her home is worth $175,000 and she owns it outright. Her monthly sources of income include Social Security of $1,250 and a pension of $1,400. She needs $3,000 per month to live on and has no other assets to generate income. Louise takes a reverse mortgage and receives a monthly payment of $505. The annual income from the reverse mortgage of $6,060 is not taxable. In addition, the reverse mortgage payment does not cause any of her Social Security benefits to be taxable.
Example #2: Jack, age 75, and Margaret, age 72, owe $20,000 on their current mortgage. Their home is worth $100,000 and their current payment on their mortgage is $700 per month. Jack and Margaret take out a lump-sum reverse mortgage of $20,000 and use it to pay off the $20,000 mortgage. They no longer have a house payment which frees up $700 per month. The amount used to pay off the original mortgage is not taxable for Jack and Margaret.
A coin has two sides. Some downside risks to plan for include:
- When interest rates rise, the cost of the reverse mortgage may increase
- Individuals seeking to qualify for public assistance may need to include income or assets generated from reverse mortgages
- The death of one of the owners or borrowers can cause the reverse mortgage to become due, even though the surviving spouse wishes to continue to live in the home
- If the intent is to leave the house to the children, the parent may use up all the equity in the home.
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