The Street: How Voluntary Reverse Mortgage Interest Payments Impact the Loan

If a borrower elects to make voluntary payments on a reverse mortgage’s interest to manage its compounding, there can be positive tax benefits for the borrower who is seeking to manage their retirement finances by the use of home equity through a reverse mortgage. This is according to Shelley Giordano, co-founder of the Academy for Home Equity in Financial Planning at the University of Illinois Urbana-Champaign and of enterprise integration at Mutual of Omaha Mortgage in a new column at The Street.

“As advisors gain knowledge of reverse mortgages, they are inclined to recommend its use to clients whose financial profile is more likely to benefit from a deduction of accrued interest,” Giordano writes. “This increased comfort with recommending a reverse mortgage is confirmed by an Academy survey of financial professionals which verified that greater education and experience levels correlate to the increased use of reverse mortgages.”

Interest is added onto the reverse mortgage loan with no mandatory monthly payments. In order to manage the compounding of interest, a borrower can elect to make voluntary payments on the loan’s interest, and the idea of making payments at certain times and suspending them in others is an idea that is picking up steam among authorities in the financial world, she writes.

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“Retirement researcher Wade Pfau […] recommends that the homeowner make voluntary payments but suspend those payments in years that a draw on retirement funds would generate stress on the portfolio,” Giordano writes. “Because there are no payments dictated by the loan terms while the borrower resides in the home, the homeowner is free to decide when and if any payment accommodates his cash flow/portfolio preservation needs.”

That’s not to say that a borrower cannot be served by the accrual of interest, however.

“There may be situations where the homeowner would allow the interest to accumulate for years, and later make a large payment to reduce the loan balance,” she writers. “Simultaneously this would create a sizeable interest deduction. As [Michael] Kitces discusses, to be most efficient, there must be enough taxable income to absorb the deduction. Kitces mentions, as well, that to absorb the interest deduction, the client could elect to take a Roth conversion.”

Making payments on variable rate reverse mortgages can also help the stature of the loan’s standby line of credit, Giordano writes.

“This revolving line is poised for funding future spending shocks, market turbulence, and/or increased longevity,” she writes. “Unlike a conventional home equity line of credit (HELOC), the lender is not permitted to cancel, freeze, or reduce the line. As the homeowner ages, his access to equity is guaranteed to grow at the rate interest is accumulating on what has been borrowed. This growth component of the [reverse mortgage] line of credit continues throughout the life of the loan regardless of the future value of the home.”

Read the article at The Street.

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  • The RMD summary above of The Street article is a poor summary of the original article. It does not even include an admonition to seek the advice of a competent tax advisor.

    Rather than relying on the information in this RMD article I strongly recommend reading the linked article itself. While there are some problems in that article, the tax information is suitable for an introduction to some tax concepts about the tax deduction for interest related to a reverse mortgage.

    Other than the grandfathering rule related to refinancing discussed in the linked article and to some degree the discussion on using a reverse mortgage to buy a new home, most of the interest on a reverse mortgage will not be deductible to the extent that interest is not related to acquisition indebtedness.

    What is clearly false in the linked article is that a reverse mortgage is never an acquisition debt. It is the proceeds that are classified, not the loan itself. For example say the buyer wisely used an adjustable rate HECM to buy a home but had $30,000 that was not used to acquire the home and 12 months later was used for medical reasons. Only the interest on the proceeds used to acquire the home would be considered acquisition indebtedness and thus only interest on those proceeds would be deductible when paid.

    It can not be said enough that reverse mortgage borrowers should seek tax advice from those are competent in the tax deduction on mortgage interest and also are competent on reverse mortgages. As with most things in life if it is free, you get what you pay for.

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