In a reverse mortgage, a mortgage lender advances money to a homeowner on the value of the property. When the homeowner dies, moves out or surrenders title to the home, the loan must be repaid. Reverse mortgages are designed for seniors who seek to draw on their home equity to help cover living expenses in retirement. Unlike a home-equity loan, the money does not have to be repaid in regular installments. As with a traditional mortgage, there are some tax implications as well.
Itemized Deductions and Schedule A
Mortgage lenders charge "origination fees" and other closing costs to borrowers, and the lenders use these fees to cover their business costs. The IRS allows taxpayers to deduct these fees, as well as loan interest and "points." The borrower deducts the origination fees on Schedule A, which lists the amount and type of all deductible expenses. Loan origination fees charged by lenders for reverse mortgages are also deductible.
HECM Origination Fees
The Federal Housing Authority sets terms in accordance with the Home Equity Conversion Mortgage program, which most lenders employ for reverse mortgages. As of 2013, the agency limited origination fees on HECM reverse mortgages at $2,500 for homes valued at $125,000 or less. For homes valued higher, the limit on origination fees is 2 percent on the first $200,000 in value and 1 percent on the amount over $200,000 (the maximum origination fee is $6,000). The borrower can pay the fee upfront or roll it into the loan. The loan becomes due upon the sale of the house, upon the owner moving out of the house or upon the owner's death. Some reverse mortgages also set a fixed loan period, at the end of which the loan and all of its costs become due and payable.
The IRS has a strict rule on deductions: Borrowers can only deduct mortgage origination fees -- as well as interest -- in the year the borrower actually paid these borrowing costs. Because no interest is actually paid on a reverse mortgage until the home is sold or the mortgage, for some other reason, is paid off, there is no deduction in the year a homeowner takes out the reverse mortgage. As for origination fees, these are deductible if the borrower pays them at closing; if they are rolled into the loan, the deduction is not available until the loan is paid off.
Origination fees may also be payable at closing if the homeowner has a high balance remaining on an existing mortgage, and the reverse mortgage amount will not cover the payoff. The homeowner would have to come up with some extra money to get the first loan paid. In addition, the origination fees may have to be paid, in part or entirely, in cash at closing. The fee would then be deductible on Schedule A.
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