Reverse Mortgages Offer Limited Tax Benefits

Seniors who want to stay in their home but need to tap into the equity might be tempted by a reverse mortgage, a controversial product that charges high fees and offers limited tax benefits.

Reverse mortgages, available to seniors 62 and older who own their house free of substantial debt, work as a loan secured by the equity in the home. The loan, which accrues interest and grows over time, is paid when the homeowner moves or dies, or at a contracted date. During the life of the loan, homeowners retain title to their home and remain responsible for maintenance and property taxes.

The most common type of reverse mortgage is the federally insured Home Equity Conversion Mortgage. More than 78,000 reverse mortgages were insured last year by HUD, according to AARP, and more that 660,000 HECMs have been issued between 1990 and 2010.

While a reverse mortgage can make sense for some investors who feel strapped for cash, advocates urge caution when considering the product. The loans come with heavy upfront fees that include mortgage insurance premiums, loan origination fees and closing costs, as well as ongoing fees for mortgage premiums, interest and servicing fees.

Reverse mortgages cost more than a traditional mortgage or home equity loan, but they offer fewer tax advantages. According to IRS rules, interest from a reverse mortgage cannot be deducted until it is paid at the end of the loan. The size of the interest deduction may be limited by IRS rules that subject reverse mortgages to the limits placed on home equity debt. The IRS limits home equity deductions to a maximum of $100,000 for a married couple filing jointly.

Payments a senior receives from a reverse mortgage are not taxable because the IRS considers them as loan advances and not income..

AARP advises seniors considering a reverse mortgage to compare the products to other options, such as selling and scaling down to less expensive housing. Seniors may also be able to refinance their home through a traditional mortgage, or take out an equity loan or line of credit.