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Tougher Rules on Reverse Mortgages
(August, 2014)


The Federal Housing Administration (FHA) has imposed more stringent requirements on reverse mortgages, making them increasingly difficult to obtain. For qualified borrowers, though, continued low rates and the spread of so-called "purchase loans" can make it worthwhile to consider this type of debt.

Income instead of outflow
As the name suggests, a reverse mortgage is the opposite of a traditional home loan. With a reverse mortgage, you get cash instead of making payments to the lender. You can get a lump sum, a line of credit, or regular monthly income. The amount you borrow will be secured by your home, so reverse mortgages are for homeowners with little or no debt on their home. Most reverse mortgages are Home Equity Conversion Mortgages (HECMs), which are offered by private lenders and insured by the FHA; borrowers must be at least age 62.

The amount you'll receive will be determined by current interest rates, your age, and your home equity. Interest rates are relatively low now (around 5% for a fixed-rate loan and under 3% for a loan with a variable rate that adjusts monthly), but you'll pay an added 1.25% of the balance for mortgage insurance. The older you are and the greater your home equity, the more you'll be able to borrow on a reverse mortgage.

Many reverse mortgage calculators can be found online. Near midyear 2014, the calculator at reversemortgage.org was asked what a married couple in Indianapolis, both aged 68, could borrow against a $320,000 debt-free home. A fixed-rate loan would permit an upfront payout of over $97,000, whereas a variable-rate loan would provide $971 in monthly cash flow. If that couple were both age 78, the numbers would be about $106,000 upfront and $1,236 a month, respectively. In any case, no tax would be due on the borrowed funds. (See the Trusted Advice column "Delayed Deduction" for more information.)

With a HECM, an owner occupant doesn't have to make any debt repayment while still living in the home. No matter how large the loan balance becomes, the outstanding loan balance won't be due until the borrower dies, sells the home, or is no longer using the home as a primary residence. Naturally, the loan balance will keep mounting: that $97,000 or $106,000 loan against a $320,000 house will approximately double in 11 years, at today's fixed interest rates.

Higher hurdles
A reverse mortgage borrower still owns the home, which means continuing to have ownership responsibility.

Example 1: Frank and Robin Grant receive a reverse mortgage that will pay them $1,000 a month. They still own their home, so they still must pay homeowners insurance premiums, local property taxes, and association dues.

Under new FHA rules, reverse mortgage applicants must undergo a financial assessment in order to qualify for a loan. Lenders have to check to see that borrowers can afford to pay the required taxes and insurance bills, based on their assets and cash flow. Borrowers with questionable resources may be asked to put money into escrow or may have their application rejected.

Borrowing to buy
Reverse mortgages are aimed at seniors who wish to stay in their home as they grow older. In effect, they can use their home equity for added cash in retirement so they won't have to move into an unfamiliar place, perhaps one that's away from friends and family.

That's not the case for all seniors. Some want to buy a different home that's easier to maintain or move to a less expensive region.

Example 2: Helen Parker is a widow living in a large house. She wants to buy a place in a seniors' community, but she lacks the income to qualify for a traditional mortgage, and she is having a difficult time selling the house where she now lives.

Fortunately, Helen has enough assets to qualify for a reverse mortgage purchase loan, which will enable her to buy into the seniors' community now. Helen still plans to sell her old home, but she can move right away and not have to make payments on the reverse mortgage purchase loan.

Reverse mortgages can be complicated, and they require various fees, but they may offer a practical way to tap home equity in specific circumstances.


Trusted Advice
 Delayed Deduction
 › 

Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable.

 › 

Any interest accrued on a reverse mortgage is not deductible until the interest is actually paid, which is usually when the loan is paid off in full. Such a payment might be made by the borrower, by an heir, or by the borrower's estate.

 › 

For the party repaying the loan, the deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt. That limit caps deductions to the interest on $100,000 of debt.



Source: August 2014 AICPA Client Bulletin


 

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