Are you a homeowner whose property value has significantly appreciated since your purchase? If you need additional or supplemental income, a reverse mortgage might be the solution. Reverse mortgages can be a beneficial option for older individuals needing additional income while staying in their homes, but it’s important to understand the terms and implications fully before proceeding. Let’s review the basics.
The Basics
A reverse mortgage is a type of loan available to homeowners aged 62 or older, allowing them to convert part of the equity in their home into cash. Unlike a traditional mortgage where the homeowner makes monthly payments to the lender, in a reverse mortgage, the lender makes payments to the homeowner.
Here’s how it works:
Eligibility: The homeowner must be at least 62 years old and have significant equity in their home.
How Funds are Obtained: The homeowner can receive the funds as a lump sum, monthly payments, a line of credit, or a combination of these options. Most reverse mortgages are so-called home equity conversion mortgages, or HECMs, and for 2024, the maximum amount you can borrow with an HECM is a whopping $1,141,825.
Note: the maximum you can actually borrow depends on the value of your home, your age and the amount of any existing mortgage debt against the property.
Interest Rates: Reverse mortgage interest rates can be fixed or variable depending on the deal. Interest rates can be higher than for regular home loans, but not a lot higher.
Repayment: The loan does not have to be repaid until the homeowner sells the house, moves out permanently, or passes away. At that point, the loan, along with interest and fees, is typically repaid from the sale proceeds of the home.
Remaining Equity: If the home is sold for more than the loan balance, the remaining equity goes to the homeowner or their heirs. If the sale proceeds are less than the loan balance, most reverse mortgages are "non-recourse" loans, meaning neither the homeowner nor their heirs owe the difference.
Tax Benefits: The funds received from a reverse mortgage are generally not considered taxable income, which can provide a tax-saving advantage.
Why a Reverse Mortgage Strategy is Helpful?
When you own a home that has greatly increased in value, selling it could mean paying a large amount in taxes, especially if the profit from the sale is much higher than the federal tax break for home sales ($250,000 for singles and $500,000 for married couples). This tax hit can be tough, particularly if you live in a state with income tax. Essentially, you lose a lot of money to taxes if you sell.
However, by choosing a reverse mortgage instead of selling your home, you can avoid this tax burden. Plus, you can get the cash you need and benefit from some tax advantages like the “step-up basis”.
What is the Step-Up Basis?
When a person dies, the federal income tax basis of any appreciated asset they owned, including their home, is adjusted to its current market value at the time of their death.
If the home's value remains roughly the same between the owner's death and the time it's sold by their heirs, there will be little to no taxable gain. This is because the sale proceeds will be nearly equal to the adjusted basis or the “step-up” value, minimizing or eliminating the taxable amount.
So, if you need cash, selling your appreciated home can lead to a big tax bill and require you to move. A reverse mortgage allows you to stay in your home and get the cash you need with lower costs (fees and interest) compared to the taxes from selling. It’s a tax-smart solution, especially with the basis step-up rule that can reduce taxes on your estate. Sounds interesting? Talk with your VAAS Pro Consultant to discuss this option further.