Reverse Mortgages and Related Taxes

One of the most highly touted advantages of a reversemortgage is that it can “provide tax-free monthly income”. While it is truethat loan advances taken through a reverse mortgage are not considered to beincome, and thus are not subject to income taxes, a reverse mortgage is notquite the same thing as tax-free income. If you are considering a reversemortgage, there are a number of things you should be aware of concerningreverse mortgages, their costs and related taxes.

Loan Proceeds are Tax-free

Due to the fact that payments from your reverse mortgage arenot earned income, you will not pay income taxes on them. This is true whetheryou choose to take your loan in a lump sum payment, as monthly payments, as aline of credit or as any combination of the above.

You will, however, retain the title to your house and stillbe responsible for paying the property taxes on the house. In fact, if you donot pay your property taxes, you will be in violation of your mortgage loanagreement, which could trigger the loan repayment. In addition, you will alsobe required to maintain homeowner insurance with replacement value for the homeitself, and may be required to carry flood insurance.

Impact of State Mortgage Taxes

While there are no federal taxes on your reverse mortgage,some states have their own regulations. Notably, Floridacharges a mortgage stamp recording tax of $.35 per $100 to record the loan, aswell as a one-time Intangibles tax of .04 per $100 when the mortgage is firstrecorded. Those two taxes must be paid up front when the loan closes.

A reverse mortgage may also affect participation in otherstate programs. In Oregon, forinstance, low-income seniors are eligible for a property tax deferral whichallows them to put off paying property taxes on a primary residence. Mostlenders of reverse mortgages require that they be the first lien holder againsta property and will require that any deferred taxes be paid off before the loanis approved, or be paid off from the proceeds of the loan.

The same holds true if there are any outstanding mortgageson the home. In most cases, you can apply for a reverse mortgage even if youhave a small outstanding balance on a mortgage or home equity loan. You will berequired to take part of the reverse mortgage proceeds in a lump sum at closingso that you can pay off the remaining balance and release the existing mortgageon the house.

Interest Payments on the Loan

Generally, interest due on the reverse mortgage will beadded to the amount of the loan month by month. That interest will not bedeductible from taxes until the loan matures and is paid off. Until that time,the interest charged is not tax deductible.

Be Wary of other Loan and Annuity Products

Some lenders may suggest that you take the proceeds of theloan and use it to purchase an annuity or other financial product. An annuitywill pay you a monthly income similar to a reverse mortgage loan, but there isa major difference for accounting purposes. In most cases, annuity payments arecounted as income, and you will be liable for taxes on that income. Be surethat you consult with a tax professional to understand all of the taximplications of your reverse mortgage and other policies.

More Information about Reverse Mortgages and Finances

A reverse mortgage can affect your finances in a number ofways, which is why HUD requires that any senior considering a reverse mortgageattend an informational counseling session with a qualified counselor. Thecounselor will explain the various options available, and make certain that youare aware of all the ramifications of taking out a reverse mortgage. There area number of common misconceptions that come up in these informational sessions.

For instance, payments from a reverse mortgage will notaffect Social Security or Medicare benefits, but they could have an effect onother benefits such as SSI or Medicaid. It is important to discuss how areverse mortgage might affect eligibility or payments through state-sponsoredprograms like Medicaid with a financial advisor before making a commitment.

Many other common beliefs about reverse mortgages are alsounfounded. Contrary to what you might hear, the bank does not own your housewhen you take out a reverse mortgage. You retain title to the house, and can leaveit to your children or other heirs. Your heirs will not be forced to sell thehouse, and the bank does not sell the house automatically when the mortgagecomes due.

A reverse mortgage can be a major part of managing financesduring retirement, but it is important to understand all of the tax and otherfinancial ramifications before making a final decision. Be sure to discuss allof your possible options with a financial advisor so that you can make theright choice for your needs.