CD Type Annuities

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

Loan Proceeds are Tax-free

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

You will, however, retain the title to your house and still be responsible for paying the property taxes on the house. In fact, if you do not pay your property taxes, you will be in violation of your mortgage loan agreement, which could trigger the loan repayment. In addition, you will also be required to maintain homeowner insurance with replacement value for the home itself, 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, Florida charges a mortgage stamp recording tax of $.35 per $100 to record the loan, as well as a one-time Intangibles tax of .04 per $100 when the mortgage is first recorded. Those two taxes must be paid up front when the loan closes.

A reverse mortgage may also affect participation in other state programs. In Oregon, for instance, low-income seniors are eligible for a property tax deferral which allows them to put off paying property taxes on a primary residence. Most lenders of reverse mortgages require that they be the first lien holder against a property and will require that any deferred taxes be paid off before the loan is approved, or be paid off from the proceeds of the loan.

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

Interest Payments on the Loan

Generally, interest due on the reverse mortgage will be added to the amount of the loan month by month. That interest will not be deductible 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 the loan and use it to purchase an annuity or other financial product. An annuity will pay you a monthly income similar to a reverse mortgage loan, but there is a major difference for accounting purposes. In most cases, annuity payments are counted as income, and you will be liable for taxes on that income. Be sure that you consult with a tax professional to understand all of the tax implications of your reverse mortgage and other policies.

More Information about Reverse Mortgages and Finances

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

For instance, payments from a reverse mortgage will not affect Social Security or Medicare benefits, but they could have an effect on other benefits such as SSI or Medicaid. It is important to discuss how a reverse mortgage might affect eligibility or payments through state-sponsored programs like Medicaid with a financial advisor before making a commitment.

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

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