Tax Implications of Reverse Mortgages

As far as taxes go, there are pros and cons to reverse mortgages.

By , J.D. · USC Gould School of Law

A reverse mortgage is a special type of home loan designed to enable older homeowners, usually 62 years of age and older, to access part of the equity in their homes. It's called a "reverse mortgage" because, instead of you paying the lender, the lender pays you. These payments can be a lump sum, a monthly advance, a line of credit, or a combination.

As far as taxes go, reverse mortgages have pros and cons.

How Does a Reverse Mortgage Work?

The three basic types of reverse mortgages are:

  • single-purpose reverse mortgages, offered by some state and local government agencies and nonprofit organizations
  • federally insured reverse mortgages, known as "Home Equity Conversion Mortgages" (HECMs) and backed by the U. S. Department of Housing and Urban Development (HUD), and
  • proprietary reverse mortgages, private loans that are backed by the companies that develop them.

When you take out a reverse mortgage, the title to your home remains with you, and you continue to live in the home. You must continue to pay for repairs, property insurance, and taxes. When you move out, sell the home, or die (or the last surviving borrower dies), you or your estate must repay the loan.

The loan balance will include the amount paid to you in cash, plus the interest and fees added to the loan balance each month. So, your total debt increases as the loan funds are paid to you and interest on the loan accrues.

Usually, when the loan become due, you or your heirs will have to sell the home and use the proceeds to pay it off. You or your heirs can keep any money left over. If you or your heirs want to retain ownership of the home, you (or your heirs) usually must repay the loan.

Reverse Mortgages Tax Implications

On the plus side, reverse mortgages are considered loan advances to you, not income you earned. So, the payments you receive aren't taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.

On the downside, any interest accrued on a reverse mortgage is considered interest on home equity debt and usually isn't deductible. You can deduct reverse mortgage interest only if you used the loan to buy, build, or substantially improve your home. To learn more about deducting mortgage interest, see IRS Publication 936, Home Mortgage Interest Deduction.

How to Choose a Reverse Mortgage

A reverse mortgage might or might not be your best option. Here are some factors to keep in mind:

  • A reverse mortgage isn't a good choice if you want to leave your home to your heirs—they will likely have to sell the house when you die.
  • Reverse mortgages work best for older homeowners who plan on living in their home for many more years.
  • If you have to move out of your home into a nursing home or assisted living facility, your reverse mortgage will become due and payable. As a general rule, you're deemed to have moved if neither you nor any other co-borrower has lived in your home for one continuous year. (In some cases, however, a nonborrowing spouse of a reverse mortgage borrower may remain in the home after the borrower moves into a long-term care or other healthcare facility. If you're considering taking out a reverse mortgage with a nonborrowing spouse, be very careful and talk to a lawyer or HUD-approved housing counselor to learn how to protect the nonborrowing spouse adequately.)
  • If you don't pay property taxes, carry homeowner's insurance, or maintain the condition of your home, your loan may become due and payable—meaning you could lose it to a foreclosure if you don't pay the loan back.
  • You might get a better deal by taking out a regular home equity loan at a lower cost.
  • If you take out a reverse mortgage without adding your spouse as a co-borrower (or listing the spouse as a "non-borrowing spouse" on the mortgage), your spouse might have to move out or repay the loan if you die before your spouse. Again, if you're thinking about getting a reverse mortgage with a nonborrowing spouse, proceed with caution and speak to a lawyer or HUD-approved housing counselor to learn how to protect the nonborrowing spouse.

Get More Information About Reverse Mortgages

Do your homework before taking out a reverse mortgage. For more information about reverse mortgages, visit the Consumer Financial Protection Bureau website (search for "reverse mortgage") and review AARP's useful articles on reverse mortgages.

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