April 17, 2021

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Mortgage News

Reverse Mortgages Aren’t Just for People Who Are Out of Money

Reverse mortgages are surprisingly unpopular when you consider that they allow you to spend the assets locked in your home without having to sell them, protect you from depreciation of the home, and even pay you monthly checks (if you so choose) for as long You do this live like social security. Less than 1% of eligible homeowners have a reverse mortgage, according to a Brookings Institution report.

The word “reversed”, which evokes images of retreat and defeat, could be the problem. Or maybe it’s “mortgage,” which is nobody’s favorite financial product. It seems like taking out a reverse mortgage is an act of desperation by people who have no choice but to break out and spend their home nest egg.

This is unfortunate because a reverse mortgage can be a smart choice for a wide range of people aged 62 and over, including those who are far from desperate. Many people who are well prepared for retirement have most of their wealth tied up in tax-privileged savings plans like 401 (k). Pulling money out of the home they live in without having to sell it can be a great way to raise money for large expenses – for example, to fund home health care or their grandchildren’s education.

A reverse mortgage loan is like a regular mortgage loan, except that principal and interest payments are optional. The interest plus the withdrawn money will be added to the balance owed. The loan becomes due when the borrower moves out or dies. At this point, the borrower – or heir if the borrower has passed away – can keep the house by paying back the loan, selling the house to pay off the debt, or, if there is no equity left, handing the keys over to the bank . The loan is non-recourse so the borrower never owes more than the house is worth.

The borrower can withdraw money in a lump sum, a line of credit, or a series of monthly payments. The flat rate could be useful for someone who suddenly needs a lot of money. The line of credit is the most flexible. The monthly payments offer longevity insurance because they last for life, even if the amount paid out far exceeds the value of the home. (Lenders are insured against this eventuality with the Federal Housing Authority.)

However a borrower pulls money out of their home, the payments are not taxable because of the Internal Revenue Service greetings it as a loan, not as income.

Where taxes become a problem is at the time of sale. The seller owes capital gains tax on the difference between the selling price and the buying price. The tax is owed to the IRS even if the borrower has to surrender most or all of the sale price to the bank to pay off the loan. That goes for any home sale, of course, but it’s more likely to sneak up on reverse mortgage borrowers who haven’t planned well. A nice feature for heirs: if the borrower dies without ever leaving the home, no capital gains tax is payable on the sale.