On February 27, 2009, RMD published Are Reverse Mortgage Proceeds Really Income? In that article the point was made that reverse mortgage payouts result in the increase of the amount due a creditor (a liability) and is not income which increases the borrower’s equity. In accounting literature, income is a temporary category of equity.
On both March 4th and 5th, while “Googling” “reverse mortgage daily”, the following ad came up in the first position on the right side of the Google results webpage:
The last line of the ad, which is a URL of the lender, was intentionally left off. The downloaded free guide only discusses reverse mortgages. All that can be concluded from that guide and the ad above is that this lender is declaring that reverse mortgages “earn tax-free income.”
Let’s be clear; if it is all right to call proceeds “income” then certainly it is appropriate to describe the growth in a HECM as “earned” and since in most cases, it is expected that the anticipated proceeds from the sale of the home net of selling expenses will exceed the amount of the reverse mortgage due at time of repayment, it may be “reasonable” to describe proceeds as “tax-free.”
In many business activities, income is earned by foregoing certain activities. For example, those holding a non-competition agreement will “earn” income by not pursuing certain business activities. Farmers “earn” government subsidies (taxable income, not loans) by not growing certain crops. So if RM proceeds are income, then to say that borrowers will earn tax-free income from not using those proceeds is clearly a logical conclusion since the amount of the available proceeds grows over the time that proceeds are not used by the borrower. This growth is also reflected in tenure payments and other periodic payouts.
Over the last few years, positive steps have been taken by many of the major marketers to move away from describing loan proceeds as “income” using terms like “cash,” “increased cash flow,” “supplement to monthly income,” and other appropriate descriptions instead. However, at the same time, there have been those who have taken the lead to create misleading ads like the foregoing.
Like the last installment, this segment also contends that it is not right to call loan proceeds “income.” In fact using that word to describe RM proceeds is not only misleading but also deceitful. Despite the actions of some, it is not smart, cute, or cleaver to call proceeds income.
When one looks at what increases the balance that a borrower owes, there is no question that accrued expenses such as servicing fees, interest, and MIP do. So do proceeds. So if loan proceeds are actually income, then both income and expenses increase debt. How is that even possible? It is utter nonsense. Proceeds are not income.
Does anyone actually believe that if a RM lender was somehow shorted on a proprietary loan (where the borrower obtained and held those “shorted” funds) that the RM lender would appear in court arguing that RM proceeds are “income” to the borrower? This article asks those leaders and originators who advocate the use of the word “income” (to describe RM proceeds) to speak up and say why it is right to do so.
The foregoing ad is wrong. When a HECM credit line grows based on the unused balance, it is an increase in the proceeds available to the borrower. The amount is not earned; it is simply a guaranteed growth factor making additional proceeds available to the borrower and is built into the terms of a HECM.
Let’s not kid ourselves. If some of our most respected leaders are intentionally endorsing the use of misleading terms (as described in the prior article), then is it really so surprising that many originators get things unintentionally wrong by carrying the actual meaning of such terms to their logical conclusions? If this is the situation in the industry then it is correct to state we market to seniors but not that we educate them. However, the vast majority of our leaders and originators are very responsible and do their best to educate; these individuals make our industry better. Let’s stop confusing seniors and ourselves; proceeds are not income.
Reader comments to the first installment of this article were excellent. Mr. Abel Torres cited a superb reference, Social Security Ruling (SSR) 92-8p which, as Mr. Torres pointed out, states in part: “A loan means an advance from lender to borrower that the borrower must repay, with or without interest” and “any advance an SSI applicant or recipient receives that meets the above definition of a loan is not income for SSI purposes since it is subject to repayment.” The reasoning in the ruling is absolutely biased; however, in this case the Social Security Administration (SSA) is looking to find income, not exclude it. It is, therefore, quite significant that SSA did not find any element of income in a bona fide loan.
Mr. W L Pulsipher informed us that his firm does not use the word “income” to describe proceeds. They call them “cash.” Others added similar insight and comments.
As Mr. Torres pleads, there are many other examples of governmental and other significant institutions concluding that loan proceeds are not income. For example, many cities base their business license fees on the income of the business. Are there any that describe loan proceeds as income for this purpose? Many of these cities desperately need revenues so if there was any way possible to justify loan proceeds as income, they would already be doing it. California is almost bankrupt but its income taxing authority, the California Franchise Tax Board (considered by many in the tax field to be the most aggressive state taxing authority in the US) has never taken the position that proceeds from bona fide debt are income. Accounting principles require entities to record loan proceeds they receive as liabilities, not income. In lawsuits attempting to collect loan proceeds, has any plaintiff (lender) ever called them “income to the borrower”? So why do those in our industry call proceeds “income”? Readers are encouraged to add other examples.
On March 20th, the final installment of this article will be short. It will be a call to all readers to cite evidence as to why it is acceptable to call loan proceeds “income.” I hope that there will be an overwhelming wealth of evidence backing up the contention that RM proceeds are income. This author has reached wrong conclusions before and it is not hard to believe it has happened again.
James E. Veale, CPA, MBT
SVP of Tax and Government Affairs & Director of Originator Recruiting for Security One Lending