The annual inflation rate in the U.S. accelerated to 7.5% in January of 2022, the highest since February of 1982, hitting those on fixed retirement income, namely seniors, the hardest.
On top of escalating living expenses due to inflation, some retirees are faced with a significant amount of debt and inadequate income. Some seniors that have a mortgage on their home have retirement income too low to cover the mortgage payments and have enough left over to be able to enjoy their golden years. Are there any remedies for this situation?
One possibility for those who have built up equity in their primary (main) home is to obtain a “reverse mortgage,” as this type of mortgage considers the homeowner’s equity. The loan is not due until the homeowner passes away or moves out of the home. If the homeowner dies, the heirs can pay off the debt by selling the house, and any remaining equity goes to them. If at that time the loan balance is equal to or more than the value of the home, the repayment amount is limited to the home’s worth.
If the borrower is married and dies before their spouse, the surviving spouse must begin or continue to occupy the home as their primary residence to keep the reverse mortgage, and the surviving spouse will need to establish proof of their legal right to stay in the home. If the spouse isn’t named as a borrower on the reverse mortgage, the loan may be due upon the borrower’s death, even if the spouse continues to live in the home.
Only borrowers aged 62 years and over with equity in the home can qualify for a Federal Housing Administration-backed loan of this type. Some private lenders have a different age requirement. Since the reverse mortgage must be a first trust deed, any existing loans on the home must be paid off with separate funds or with the proceeds from the reverse mortgage. The amount that can be borrowed is based upon age – the older the borrower, the larger the reverse mortgage can be and the lower the interest rate. The loan amount will also depend on the value of the home, interest rates, and the amount of equity built up. Over time, the amount of the loan will increase as the deferred interest payments, loan fees not paid up-front, and servicing fees are added to the original loan amount.
The borrower has the option of taking the loan as a lump sum, a line of credit, or fixed monthly payments. In addition, the money generally can be used for any purpose, without restrictions imposed, so long as any prior mortgage on the home has been paid off.
To determine whether the interest on a reverse mortgage is tax-deductible, these factors are considered:
- Interest (regardless of type) is not deductible until paid. A reverse mortgage loan is not required to be repaid if the borrower lives in the home. Therefore, the interest on a reverse mortgage is not deductible by anyone until the loan is paid off.
- Unless there is an existing acquisition loan on the property, the reverse mortgage loan would be an equity debt and interest on equity debt is not currently deductible.
So, who deducts the interest when the loan is paid off?
Debtor – If the borrower pays off the loan while still living, the borrower, if itemizing deductions, is the one who deducts the sum of the interest they would have been entitled to deduct each year had it been paid, subject to the limitations discussed in 1 & 2 above.
Estate – After the borrower passes away and their estate pays off the loan, the estate would deduct the interest on its income tax return. The amount deductible would be the sum of the interest the borrower would have been entitled to deduct each year had the borrower paid it, subject to the limitations discussed in 1 & 2 above.
Beneficiary – If the beneficiary who inherits the home pays off the mortgage, the interest would be deductible as an itemized deduction on that individual’s personal 1040 income tax return for the payoff year. The amount deductible would be the sum of the interest the borrower would have been entitled to deduct each year had they paid it, subject to the limitations discussed in 1 & 2 above. If there is more than one beneficiary who pays off the mortgage, any beneficiaries who itemize deductions on their personal 1040s would be allowed to deduct their share of the allowable interest in proportion to the amount of the loan that each has paid off.
Reverse mortgages have brought financial security to many seniors so that they can live a comfortable life. If you are a senior who is struggling with your finances, carefully explore your options, including the possibility of a reverse mortgage. However, reverse mortgages should be approached with caution and other options explored first. For instance, some reverse mortgages may be more expensive than traditional home loans, and the upfront costs can be high, especially if you don’t plan to be in your home for a long time or only need to borrow a small amount. Also, since you remain the owner of the home, you continue to be responsible for paying property taxes, insurance, utilities, maintenance, and other expenses related to the home. Failing to pay these expenses could result in the lender requiring the reverse mortgage to be repaid.
If you would like to explore your options for increasing your cash flow or have questions about reverse mortgages, please give our office a call.