For retirees looking for freedom and choice, reverse mortgages are often a great financial option. Not only do they offer residents the ability to live from their hard work without continuing to slave away, they also offer many tax benefits. Here are some of the relevant questions to ask yourself if you are considering a reverse mortgage for your retirement.
What is a reverse mortgage?
In order to avoid reverse mortgage scams, you must know what a true reverse mortgage is, who can give them out, and how taxes accrue on them.
There are three basic types of reverse mortgages. The first is a single purpose reverse mortgage, a program that is offered by states and cities, as well as non-profit organizations. The second type of reverse mortgage is one that is insured by the federal government. The agency that is responsible for them is the United States Department of Housing and Urban Development (HUD), and they are called Home Equity Conversion Mortgages (HECMs). The third type is the proprietary reverse mortgage, which is the private option.
Under no circumstances should you relinquish the title to your home under the auspices of a reverse mortgage. This is often a scam that unscrupulous companies run on unsuspecting retirees. One of the advantages of a reverse mortgage is that you get to keep your title, which is fair because you are still responsible for all of the repairs and the property taxes on the home.
For the most part, reverse mortgages do not need to be paid back until the last resident in the household dies or moves out of the house for more than one year. For instance, if both residents of the home move into assisted living, the bank might call in the loan. Federally insured loans are the most lenient if you do not think that you will be able to pay the loan back immediately upon moving out. However, you should go over the terms of your contract thoroughly with your lender before committing to any reverse mortgage.
How are my taxes assessed during a reverse mortgage?
Because there is no mortgage interest on a reverse mortgage, you do not receive the tax benefit of a reverse mortgage in the same way that you receive it during a regular mortgage. The first benefit is that you pay no taxes at all when you are receiving the funds. The government considers these reverse mortgage payouts a loan to you, not income, so they are not taxed until you actually begin to pay the loan back. As stated before, residents that are taking out a reverse mortgage usually do not have to pay back the money until they move out of the house or die. This is one of the best tax deferral programs of any income generating program available to the average person.
If you or your heirs choose to begin paying back the reverse mortgage, the payments that you give are subject to the same rules as any other mortgage. You will receive a tax benefit for mortgage interest; however, there is usually a limit of $100,000 on this benefit.
Can IÂ take advantage of both tax benefits while I receive income from the reverse mortgage?
Some very lucky retirees may have the ability to prepay on some of the distributions that a reverse mortgage gives. In the case of prepayment, the retiree will be able to take advantage of two tax advantaged programs: the tax deferral on the reverse mortgage and the mortgage interest deduction on the mortgage payments up to $100,000. This can be quite advantageous with an adjustable rate mortgage that has a low interest rate in the first place. You will be able to access these funds in the future in the case of an adjustable rate mortgage, but not in the case of a fixed rate mortgage.
Keep in mind that if you pay back the loan in full, the terms will actually cease and the loan will end. You will have to take out another reverse mortgage if you do this, which is not a bad strategy under certain situations. For instance, you may pay off one reverse mortgage in order to negotiate a lower interest rate on another. Adjustable rate HECMs can actually increase over time with a good payment history, giving a retiree even more elbow room to work with years down the road. This can also be used to negotiate a higher monthly payment to retirees for a bigger budget every month.
No matter your choice of retirement locations, a reverse mortgage will give you an advantage over your current financial situation as well as your taxes. Talk your options over with your banker and tax accountant before making any final decisions, and make sure that you understand all of the differences between the three major types of reverse mortgage programs. Although there are not many major differences in the ways that taxes are assessed, you may be able to take advantage of certain kinds of differences within each program.
2 Point Highlight
The government considers these reverse mortgage payouts a loan to you, not income, so they are not taxed until you actually begin to pay the loan back.
In the case of prepayment, the retiree will be able to take advantage of two tax advantaged programs: the tax deferral on the reverse mortgage and the mortgage interest deduction on the mortgage payments up to $100,000.
