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The answer to the common reverse mortgage tax question

February 16, 2013

Reverse Mortgage Tax Deduction?As people are preparing their taxes, I’ve been receiving the question, “Is the interest on my reverse mortgage deductible?”  So let me answer this question for you.

For interest to be a tax deduction for individual taxpayers, it must first be paid.  Being one is not making payments on their reverse mortgage, the interest is not being paid but accruing on the loan along with the FHA Mortgage Insurance Premiums (MIP) and servicing fees (applicable on some reverse mortgages).  Therefore the interest is not a tax deduction until it’s actually paid.

For FHA Mortgage Insurance Premiums IRS states, “You can treat amounts you paid during 2012 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt, and the insurance contract must have been issued after 2006.”  However, as with the interest on a reverse mortgage, the MIP amount must first be paid.

There is a way to receive the tax deduction during the term of the reverse mortgage loan.  While payments are not required with the reverse mortgage, borrowers may choose to make payments.  There are no penalties for making these pre-payments and the borrower has the option on when and how much they may choose to pay.

Payments reduce the Unpaid Principal Loan Balance.  The loan balance is made up of the following categories: MIP, Servicing fee, interest, and principal amount (sum of amount borrowers obtain for their use, i.e. paying off previous loans and liens, other closing fees, and other personal uses). When borrowers make payments to reduce the loan balance they are first applied to the MIP, then the servicing fees, then the interest followed by the principal balance.

Once the borrower has paid enough to cover the accrued MIP, service fees, then additional payment amounts are applied to the interest on the loan.  When interest paid in a calendar year exceeds $600 the lender will send you a 1098 int tax form for the amount of interest paid.

Since the payments have to cover the initial MIP of 2% of the Maximum Claim Amount, then the on-going MIP that has accrued along with any servicing fees before they are applied to the interest, most borrowers don’t find it feasible to take the deduction.  The loss of a tax deduction may be considered a negative of the reverse mortgage for some people but the pros and cons need to be weighed.

Making pre-payments on one’s reverse mortgage may still be beneficial in reducing the Principal Loan Balance. And if one has an adjustable rate, having access to the funds in the future.

If one has the adjustable rate HECM the full payment amount can:

  • be applied to create or increase the line of credit in which these payments can be borrowed in the future;
  • or applied to their monthly payment to increase the amount they receive monthly or the length time they receive the monthly payments.
  • If not specified, the payment amount will be applied to or create a line of credit.

If one has a fixed rate reverse mortgage the payment reduces your loan balance as outlined above but the funds do not become available to re-borrow in the future.

Keep in mind that payment in full will terminate the loan and eliminate any available term/tenure payments and/or line of credit.

When the loan is paid in full the interest will have been paid and could become a deduction at that time to the borrower or their estate.

Reverse Mortgage beneficial even without tax deductionMost seniors who do a reverse mortgage do not have a significant income tax burden therefore a tax deduction is not a large concern for them.  Many borrowers feel that receiving funds for one’s needs and desires with no required monthly mortgage payments outweigh the loss of the tax deduction.  They want to live comfortably, have some “elbow room,” and be independent with security, independence, dignity and control.

I am a reverse mortgage expert, not a tax expert or advisor.  Check with your tax advisor or IRS regarding tax deductions for your individual situation.

©2013-2014 Beth Paterson https://bethsreversemortgageblog.wordpress.com 651-762-9648

This material may be re-posted provided it is re-posted in its entirety without modifications and includes the contact information, copyright information and the following link: http://wp.me/pxPEm-Dk

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2 Comments leave one →
  1. Jim Dean permalink
    February 23, 2013 7:30 am

    Beth,

    I have a few observations on this topic, based on my 13+ years as a HECM originator, and the fact that I am myself a HECM borrower who does make payments on his HECM, and thus receives notice of interest and MIP paid.

    First of all, unless one itemizes deductions, neither interest nor MIP can be deducted. Secondly, the IRS rules on MIP are pretty restrictive, and many people (including me) do not qualify to deduct MIP. It is reported on a separate box on the 1098 or equivalent form, so it is not lumped together with the interest paid.

    Thirdly, it seems that the IRS regards the HECM as a home equity product (perhaps not if used for purchase) and thus interest deductibility is governed by the rules on home equity interest, not mortgage interest. In effect, most of the time interest is only deductible on the first $100,000 of home equity debt.

    So the tax deduction benefit of paying down your HECM is limited. But the repay and redraw feature is great. And the unused LOC basically increases at the combined interest and MIP rate, giving me a federally insured (perfectly safe, with no risk of loss of principal), non-taxable rate of return that cannot be matched anywhere. For the life of me I cannot understand why anyone would want to refinance with a forward mortgage, condemning themselves to a life sentence of mortgage payments, if they are eligible for a HECM on which they can derive unique benefits from now-optional repayment while they live in the home. But you never see a financial advice columnist discuss that option.

    Jim Dean
    NMLS#404697

    • February 23, 2013 11:09 am

      Thank you for sharing your experience as an originator and HECM borrower, especially one who does make payments. It’s likely that most reverse mortgage borrowers do not itemize deductions but I have received the question about the interest several times as well a couple about the MIP.

      I agree the repay and redraw feature is a great benefit even without looking for or needing a tax deduction.

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