As people are preparing their taxes, I’ve been receiving the question, “Is the interest on my reverse mortgage deductible?” So let me answer this question for you.
For interest to be a tax deduction for individual taxpayers, it must first be paid. Being one is not making payments on their reverse mortgage, the interest is not being paid but accruing on the loan along with the FHA Mortgage Insurance Premiums (MIP) and servicing fees (applicable on some reverse mortgages). Therefore the interest is not a tax deduction until it’s actually paid.
For FHA Mortgage Insurance Premiums IRS states, “You can treat amounts you paid during 2012 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt, and the insurance contract must have been issued after 2006.” However, as with the interest on a reverse mortgage, the MIP amount must first be paid.
There is a way to receive the tax deduction during the term of the reverse mortgage loan. While payments are not required with the reverse mortgage, borrowers may choose to make payments. There are no penalties for making these pre-payments and the borrower has the option on when and how much they may choose to pay.
Payments reduce the Unpaid Principal Loan Balance. The loan balance is made up of the following categories: MIP, Servicing fee, interest, and principal amount (sum of amount borrowers obtain for their use, i.e. paying off previous loans and liens, other closing fees, and other personal uses). When borrowers make payments to reduce the loan balance they are first applied to the MIP, then the servicing fees, then the interest followed by the principal balance.
Once the borrower has paid enough to cover the accrued MIP, service fees, then additional payment amounts are applied to the interest on the loan. When interest paid in a calendar year exceeds $600 the lender will send you a 1098 int tax form for the amount of interest paid.
Since the payments have to cover the initial MIP of 2% of the Maximum Claim Amount, then the on-going MIP that has accrued along with any servicing fees before they are applied to the interest, most borrowers don’t find it feasible to take the deduction. The loss of a tax deduction may be considered a negative of the reverse mortgage for some people but the pros and cons need to be weighed.
Making pre-payments on one’s reverse mortgage may still be beneficial in reducing the Principal Loan Balance. And if one has an adjustable rate, having access to the funds in the future.
If one has the adjustable rate HECM the full payment amount can:
- be applied to create or increase the line of credit in which these payments can be borrowed in the future;
- or applied to their monthly payment to increase the amount they receive monthly or the length time they receive the monthly payments.
- If not specified, the payment amount will be applied to or create a line of credit.
If one has a fixed rate reverse mortgage the payment reduces your loan balance as outlined above but the funds do not become available to re-borrow in the future.
Keep in mind that payment in full will terminate the loan and eliminate any available term/tenure payments and/or line of credit.
When the loan is paid in full the interest will have been paid and could become a deduction at that time to the borrower or their estate.
Most seniors who do a reverse mortgage do not have a significant income tax burden therefore a tax deduction is not a large concern for them. Many borrowers feel that receiving funds for one’s needs and desires with no required monthly mortgage payments outweigh the loss of the tax deduction. They want to live comfortably, have some “elbow room,” and be independent with security, independence, dignity and control.
I am a reverse mortgage expert, not a tax expert or advisor. Check with your tax advisor or IRS regarding tax deductions for your individual situation.
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