Financial Advisors Highlight Reverse Mortgages in Retirement Planning

In response to Sarah and John Rummages question, the following is a list of possible "disadvantages" to reverse mortgages that I include in a class I teach on the subject:

MAY REDUCE HOME EQUITY LEFT TO HEIRS

MAY REDUCE FUNDS FOR LATER ADMISSION TO RETIREMENT OR ASSISTED LIVING FACILITY

MAY HAVE SIGNIFICANT TRANSACTION COSTS

COMPOUND INTEREST….IN REVERSE

NO ADDITIONAL FINANCING SECURED BY HOME

DEFERS MORTGAGE INTEREST TAX DEDUCTION

NO TRADITIONAL ESCROW ACCOUNT FOR TAX & INSURANCE

BALLOON PAYMENT AT TERMINATION - CAN NOT CONTINUE LOAN BY HEIRS

MAY REQUIRE SALE OF HOME UPON TERMINATION EVENT

MAY IMPACT ELIGIBILITY FOR SUPPLEMENTAL SOCIAL SECURITY (SSI), MEDICAID AND/OR OTHER “MEANS TESTED” ENTITLEMENT PROGRAMS

Unfortunately, these are usually taken out of context and stated as "absolutes" and reasons to avoid reverse mortgages. They must be evaluated in light of individual circumstances where they may or may not apply or have relevance.

Mr. Warns,

I chuckled upon reading that reverse mortgages cause interest to compound in reverse. Yet speaking clearly, if all accruing costs are not paid monthly, they will compound to the extent not paid including MIP.

The other interesting point is that you claim reverse mortgages defer the deduction of home mortgage interest. Yet, a reverse mortgage is not what dictates what tax year the deduction of home mortgage interest takes place but rather the deferral of the payment of that interest by the borrower if the borrower deducts home mortgage interest on the cash method of tax accounting (which is the tax method selected for home mortgage interest deductions by all but a hand full of individual income taxpayers).

I do not believe we disagree but we do word what we say much, much differently.

Mr. Piotrowski,

With the advent of financial assessment, we now have income and credit qualifications; however, we still do not have FICO minimum score qualifications.

Why are credit lines just for emergencies? They are not limited to emergencies; they can be used for any purpose.

A reverse mortgage can certainly be upside down meaning the balance due can exceed the value of the home; however, a lender cannot obtain a deficiency judgment against the borrower or the estate of the borrower including heirs at loan termination. For example, the home can be worth $400,000 today and the balance due is $401,000. Next month the value of the home can be $404,000 and the balance due is $403,500. The only time the underwater issue comes into play is at loan termination.

Finally loan proceeds are generally not taxable at distribution but like all nonrecourse loan proceeds can become part of taxable gain at loan termination if the balance due is not repaid in full by the borrower; however, it is rare for that situation to occur.

Mr. Veale -

My list was just that - a list, not a discussion of each point.

A fuller discussion - as you provided - of each point would likely confirm your suggestion that we do not disagree.

Mr. Veale,

This is the first time I am reading about the possibility of a taxable gain on any portion of the loan balance that was "under water".

However, I do have a question regarding that, if the borrower is paying MIP and the FHA covers that shortfall, then wouldn't that be considered insurance proceeds and therefore not taxable?

Also, I imagine that this can be leaving a tax liability for the estate if the borrower has other assets. Am I correct?