The American Association of Retired Persons reports that from 1990 to 2010 lenders issued more than 660,000 reverse mortgages to homeowners age 62 and older. Similar to a home equity loan or home equity line of credit, a reverse mortgage offers a way for you to borrow cash based on the equity in your home. It differs significantly from a regular mortgage loan, because you don’t have to pay back the loan until you sell the home, move out of the home permanently, or die.
Mortgage Fees and Interest
Loan origination fees on a mortgage -- called "points" -- are usually a percentage of the loan amount, paid over and above the loan amount up-front, which the Internal Revenue Service considers a form of prepaid interest and allows deductions for under certain rules. A reverse mortgage doesn't require you to pay a loan origination fee up-front. Instead, the lender adds the costs to the loan balance. The same goes for the interest that accrues over the life of the loan, which is added to the principal loan balance each month. Consequently, any form of mortgage interest you pay, whether called a fee or interest, is not tax deductible until the time the reverse mortgage loan is paid off, points out Golden Years Mortgage Solutions, based in California.
Once you or your heirs pay the loan in full and can take the home mortgage interest deduction, the write-off is usually limited. While a reverse mortgage loan qualifies as home equity debt, the IRS sets a limit on how much mortgage interest you can deduct. The date and amount of the loan, and the way you use the proceeds, are all factors that determine the limit. IRS Publication 936 discusses in detail the limits that may apply to the deductibility of your reverse mortgage interest expense.
An important tax consideration that may increase your tax liability when you take out a reverse mortgage is the loss of the mortgage interest deduction you claim on your taxes each year, notes an article published in a 2006 issue of the “Journal of Accountancy.” If your existing mortgage is paid in full and you can no longer take the home mortgage interest deduction, it won't matter. But if you still owe a balance on your current mortgage and refinance with a reverse mortgage, you lose claiming the interest as an annual itemized deduction.
Cost of Origination Fees
To help make reverse mortgages more affordable, many lenders are reducing the amount of the origination fees they charge or doing away with them completely, points out Barbara Stucki, vice president of home equity initiatives at the National Council on Aging, in a Bankrate article. While an origination fee is a percentage of the loan amount, some banks charge a higher interest rate on the loan in exchange for charging a lower or no origination fee. Origination fees for reverse mortgages insured by the Federal Housing Administration are capped at $6,000.
Like deductions for which you qualify, nontaxable income lowers the amount of taxes you owe. This is good news when you take out a reverse mortgage. The IRS considers a reverse mortgage a loan advance and not income. Therefore, the lump sum payment or monthly advances you receive are not taxable. If you are looking for additional ways to save money on your taxes, since you still own your home, you can claim the real estate taxes you pay if you itemize deductions on Form 1040, Schedule A.
- AARP: 10 Things You Should Know About Reverse Mortgages
- Golden Years Mortgage Solutions: Reverse Mortgage Tax-Deductible?
- IRS.gov: Publication 936
- Journal of Accountancy: Going Forward with Reverse Mortgages
- Bankrate: Reverse Mortgage Gets Affordable
- HUD.gov: FHA Reverse Mortgages (HECMs) for Seniors
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.