Lenders Anticipating Reverse Mortgage Program Changes

NewImage.jpgOnce considered a product with high fees and pressure sales tactics, the reverse mortgage industry has steadily improved its procedures and image according to US News and World Report.

With rates and fees lowered, improved consumer disclosure, and the federal government’s insured reverse mortgage program has helped provide stability and credibility to the industry says Us News.  However, the industry has had a hard time finding new customers.

The biggest reason is because of the principal limit reduction in October, which lowered the amount seniors receive from a reverse mortgage by 10%.  With so much uncertainty about what the program will look like in the next few months, lenders are anticipating changes.

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“There is no question that the product is going to be altered again. The only question is by how much,” says Jeff Lewis, head of Generation Mortgage. He supports the idea of a non-subsidized program but believes the government should adopt a broader definition of budget neutrality. In addition to direct subsidy costs, for example, he says reverse mortgages also generate taxable income to investors and that this benefit should be part of a broader measure of the program’s budget impact.

The reality is that the costs of reverse mortgages have come down and even the National Consumer Law Center acknowledges it. However, it notes that the lower loan charges are generally only available on loans where consumers pull down all their remaining home equity in a lump sum and it may not always be the best choice for borrowers.

Lewis addresses why the HECM fixed is seeing better pricing to US News:

“If a borrower takes out a line of credit, we don’t have a very large loan to sell,” Lewis explains, which is why recent price breaks have not been offered on line-of-credit reverse mortgages. He agrees it would be better for the market to have more line-of-credit loans, and that this use of the product would permit the kind of financial planning he advocates. In some situations, for example, it would be better for retirees to spend down their home equity while keeping funds in their retirement accounts. The accounts are likely to appreciate more than their home equity, and may carry tax advantages as well.

“Clearly, that’s not been going on,” Lewis says. “The majority of the loans we do are retiring other liens on the property. We’re not doing reverse mortgages for people whose homes are fully paid up. . . . We seem to be primarily helping people who are close to running out of their other sources of money.”

Reverse Mortgages Aren’t Catching On

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  • The article is very good. It is fair, balanced, and very well reasoned.

    As usual Mr. Lewis makes some great points on HECMs. I find his point on the income generated to investors somewhat weak and suspect because there are no income taxes on interest earned following assignment (since HUD owns the loan during that period) and any increase in income taxes may be more than offset by the potential reduction in income tax liabilities due to the eventual deductibility of all or a portion of interest accrued by borrowers and heirs when the interest is paid or the loan is refinanced.

    However, there is also the potential for increased income taxes on accrued interest and principal upon foreclosure, short sale, etc. to the extent these items are forgiven. That is why it is wrong to say loan proceeds are tax-free.

    But where I differ with Mr. Lewis is encouraging and promoting the idea that reverse mortgage proceeds be used to recover investments or replacing retirement income. A well published financial advisor makes such claims but these ideas are full of risk and few can demonstrate the economic substance of such planning after considering all costs. I have heard the same claims about annuities…. Of course my crystal ball is cracked and cloudy while theirs seem to be smooth and clear.

  • “However, there is also the potential for increased income taxes on accrued interest and principal upon foreclosure, short sale, etc. to the extent these items are forgiven. That is why it is wrong to say loan proceeds are tax-free.”

    Mr. Veale, you have made this point before, though there have been as many arguments made that a short-fall in HECM pay off covered by FHA is an insurance benefit for which a premium has been paid and thus does not qualify as debt forgiveness. To your knowledge, have there been tax case rulings and/or IRS guidelines issued on this issue?

  • Dear “cracked and cloudy”,

    Jeff Lewis was referring to the tax paid by the secondary market investors who purchase reverse mortgages, not the borrowers, as an area of overall federal give and take that had not been spelled out as part of the HECM federal budget discussions.

    • Mr. Peters,

      It is interesting you do not believe that issue was addressed in the comment; I apologize for the lack of clarity. Perhaps the comment presumes too much knowledge about U.S. tax law. So here is the expanded version with further information.

      First, how can we be sure any U.S. income tax is being paid by investors? By U.S. tax treaties many nonresident aliens do not pay any (or very little) income tax on interest income earned on U.S. related investments. I know of no data that is gathered that identifies what portion of the interest earned on these loans have any income tax paid on them at all.

      Also many U.S. taxpayers will not pay any taxes on these mortgages until they are first paid the interest which will generally be no later than assignment to HUD. If paid in the right year(s), some U.S. investors could have sufficient deductions and credits to avoid any potential taxes whatsoever. If they are bound up in pension plans, 401(k)s or IRAs, it may be decades before taxable distributions are made; in some cases they may not taxable at all. Some are owned by tax-exempt entities which pay no income tax on interest earned.

      Now let’s look at assignment. Once a HECM is assigned, the government gets no increased income tax revenues because HUD owns the loans. During that period HUD earns interest on the HECMs and pays out interest to the Treasury for the monies borrowed to acquire and hold the HECMs while the HECMs are assigned. Let’s say that in a best case scenario it is a wash. Remember though almost all of the HECMs held right now are older adjustable rate HECMs with low interest rates accruing on them and thus the cost of borrowing money from the U.S. Treasury could far exceed the minimal interest earned on them; however, that loss is supposedly reflected in the annual budget for each cohort. Let’s just say there is no net interest (arbitrage) income from assignment.

      Now out of fairness to the U.S. government and out of the spirit of the program paying its own way let’s look at tax dollars lost to the U.S. Treasury as a result of interest deductions for home mortgage and other statutory areas. Since all borrowers must be U.S. citizens or resident aliens of the U.S., all of the homes must be the principal residence of borrowers, and none of the homes can be outside of the U.S. or its possessions, all of these dollars are eligible for deduction when paid (or in some cases even as accrued).

      Since the deductions can potentially include all interest accrued including that while the loan is held in assignment, all of a sudden we have more interest potentially eligible for deduction than potentially subject to income tax. So the question is based on the economic logic of Mr. Lewis, aren’t borrowers already potentially getting an enormous net income tax subsidy?

      (Now there is another potential source of increased tax revenues and that comes from foreclosure. But that amount is probably insignificant and could lead to greater deductibility of interest which because of some income exclusion rules could lead to more deduction of interest than increased gross taxable income. These rules get complicated.)

      So now let’s look at where we are at. Perhaps, just perhaps, the decreased tax revenues from interest deductions far exceed any income taxes investors pay.

      I know that I for one would not want to be floating the idea proposed by Mr. Lewis before Representative Rangel (if he is cleared of all charges and returns as the Chairperson over the powerful House Ways and Means Committee). He could cut right through this argument like a heated and sharp knife through room temperature butter.

      I hope you are getting a better idea why I think the argument is as “cracked and cloudy” as my crystal ball.

  • James,
    Can you explain furtherthe potential for increased income taxes on accrued interest? Are you suggesting borrowers receive interest income from reverse mortgages?

    • guest,

      This is not interest income. This is the liability for interest. When a liability is forgiven by a mortgagee, a taxable event occurs.

      • Mr. Veale, you have made this point before, though there have been as many arguments made that a short-fall in HECM pay off covered by FHA is an insurance benefit for which a premium has been paid and thus does not qualify as debt forgiveness. To your knowledge, have there been tax case rulings and/or IRS guidelines issued on this issue?

  • Mr. Veale, you have made this point before, though there have been as many arguments made that a short-fall in HECM pay off covered by FHA is an insurance benefit for which a premium has been paid and thus does not qualify as debt forgiveness. To your knowledge, have there been tax case rulings and/or IRS guidelines issued on this issue?

  • REVGUYJIM,rnrnThe Internal Revenue Code (u201cIRCu201d) addresses FHA insurance but only as to its deduction. There is nothing in the IRC about the exclusion of benefits yet there is a specific provision on the exclusion of benefits for income related to premiums on life insurance but only when paid in connection with the death of the insured along with a provision on the deductibility of limited amounts of term life insurance for employees. There are also specific IRC provisions on the deductibility of health insurance premiums and the partial or full exclusion of their benefits. There are also provisions related to personal injury insurance.rnrnThere are no provisions on insurance like business interruption insurance. All such benefits are taxable when paid.rnrnAs to Treasury Department or Internal Revenue Service official or unofficial positions, I am not aware of one single document. Because there is no law, neither Treasury nor the IRS can make their own rules. My former industry would absolutely come unglued over it. We all play by the same rule book.rnrnAs to court decisions, they fall into three distinct categories: disputes of law, disputes of facts, and disputes based on equity. Disputes of law are common because the IRS takes one position on a law and taxpayers, another. rnrnAs to facts, these arise when the application of law is agreed but the actual facts are not. An example is the payment of cash by a corporation to a shareholder who is also an employee where the corporation deducted all of it as compensation but the IRS is arguing a part or all of it should not be deducted because it is a disguised dividend.rnrnThe final category is rare because tax disputes on this level can only be heard by one court, the U.S. Court of Federal Claims, and to get there, all the amounts in dispute must have been paid by the taxpayer. These cases are a mixed bag of results.rnrnBut the final result is no court has entertained a case based on the exclusion of FHA insurance from income. Since there is no law on point, it is frivolous on its face. To the best of my knowledge and research, there has never been an attempt by the IRS to force a taxpayer to recognize income from that source although perhaps it could be theoretically argued. rnrnHere is the crux of the legal issue: Is the borrower even responsible for any loss on the loan other than through fraud? If a HECM is nonrecourse, the borrower is not responsible for any loss ever; thus to the borrower at termination FHA insurance provides no special protections or benefits. rnrnSo here is the question you need to answer: If FHA insurance cannot be paid to the lender for any reason (other than the direct fraudulent actions of the borrower), is the borrower responsible for repayment of the difference between the balance due and the market value of the home? If the answer is yes, a HECM is not nonrecourse, it is simply an insured recourse loan. If it is no, the income tax impact is no different than a proprietary reverse mortgage which has no FHA insurance.rnrnThe problem for most observers is somehow in some odd way the FHA insurance clouds the issue. It should not. To qualify as a HECM, the note must be nonrecourse. rn

    • Thank you so much for your thorough reply to my question. Clearly a complex issue, it will take me some time to sort it out – thanks again for assisting me in this process.

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