What Are the Tax Benefits of a Reverse Mortgage?
Most people spend years paying off their mortgage, but what if your home could start paying you back? That’s the idea behind a reverse mortgage, it lets homeowners 62 and older turn their home equity into cash without selling or making monthly payments, as long as they stay current with taxes and insurance payments.
But does that mean you have to report reverse mortgage payments as income? Can you deduct the interest? Will it mess with Social Security or Medicare? The tax side of things can be confusing, but don’t worry, we’ll break it all down in simple terms.
If you're curious about how a reverse mortgage could work for you, check out your options with Rate.
What Is a Reverse Mortgage?
A reverse mortgage is a type of loan designed for homeowners aged 62 and older who want to access their home equity without selling or making monthly payments. Instead of paying a lender each month, the lender pays you, using your home as collateral.
You can receive the funds in different ways as a lump sum, fixed monthly payments, or a flexible line of credit you can draw from as needed. The loan doesn’t have to be repaid until you move out, sell the home, or pass away. At that point, the loan balance, including accrued interest, is typically paid off through the sale of the home.
Reverse mortgages can be a useful financial tool, but they’re not for everyone. Understanding how they work, and how they impact your finances, is key to making the right decision.
Do Reverse Mortgage Payments Count as Income?
Good news: the money you receive from a reverse mortgage isn’t considered taxable income. The IRS treats it as loan proceeds rather than earnings, which means you won’t have to report it as income when you file your taxes.
Even better? Because it’s not classified as income, a reverse mortgage won’t impact your Social Security or Medicare benefits. However, if you receive needs-based benefits like Medicaid or Supplemental Security Income (SSI), you’ll need to be careful.
If you don’t spend the money within the same month you receive it, it could count as an asset and affect your eligibility.
Who Benefits Most from a Reverse Mortgage?
A reverse mortgage can be a great option for homeowners who:
- Have built up significant home equity.
- Need extra cash to cover daily living expenses or medical costs.
- Want to stay in their homes during retirement instead of downsizing.
It can also be a way to supplement retirement income without taking on new monthly payments. However, reverse mortgages aren’t the right fit for everyone.
If you plan to move in the near future or want to leave your home to heirs without them having to sell it, you may want to consider other options. Consulting with a financial advisor can help you determine if a reverse mortgage aligns with your long-term goals.
Can I Deduct Reverse Mortgage Interest?
Unlike traditional mortgages, where you can deduct interest payments each year, reverse mortgage interest isn’t deductible annually. That’s because the interest accrues over time and is only deductible once it’s actually paid, which usually happens when the loan is settled in full.
There’s another limitation to consider, the IRS generally only allows interest deductions on home acquisition debt, which means the loan must be used to buy, build, or significantly improve the property.
Since most reverse mortgage borrowers use the funds for living expenses rather than home renovations, the interest may not be deductible at all.
If tax deductions are an important part of your financial strategy, it’s worth speaking with a tax professional to understand how a reverse mortgage fits into the bigger picture.
What Happens to the Interest on a Reverse Mortgage?
Interest on a reverse mortgage doesn’t just sit still, it compounds over time. Since you’re not making monthly payments, the interest is added to your loan balance, which grows larger as the years go by.
When the loan becomes due, typically when you sell the home, move out, or pass away, the accumulated interest, along with the original loan amount, must be repaid. This is usually done by selling the home, but your heirs can also choose to pay off the loan themselves if they want to keep the property.
Because interest continues to grow, the total loan balance can end up being more than the home’s original value. However, FHA-insured reverse mortgages (Home Equity Conversion Mortgages, or HECMs) include a non-recourse feature, which means you or your heirs will never owe more than the home is worth.
Who Pays Property Taxes in a Reverse Mortgage?
Even with a reverse mortgage, you’re still responsible for property taxes, homeowners insurance, and maintenance. These costs don’t go away just because you’re no longer making traditional mortgage payments. In fact, keeping up with these expenses is critical, falling behind could put you at risk of default, which might lead to foreclosure.
Lenders often assess your ability to cover these costs before approving a reverse mortgage. In some cases, they may set aside a portion of your loan to ensure property taxes and homeowners insurance get paid. This is called a Life Expectancy Set-Aside (LESA) and is commonly required for borrowers who might struggle to keep up with ongoing expenses.
If your taxes and insurance lapse, the lender can demand repayment of the loan, so it’s essential to budget for these costs even after getting a reverse mortgage.
Tax Implications of a Reverse Mortgage
One of the biggest perks of a reverse mortgage is that the money you receive is usually tax-free. But that doesn’t mean there aren’t tax considerations to keep in mind.
Reverse Mortgage Interest
Since reverse mortgage interest isn’t paid monthly, it accrues over time. That interest isn’t tax-deductible until the loan is fully repaid, which usually happens when the home is sold or the loan balance is paid off in full. Even then, there may be limitations on how much can be deducted.
For interest to be deductible, the loan proceeds must have been used for a qualifying purpose, like home improvements. If the money was used for everyday expenses or medical bills, the deduction may not apply.
Social Security and Medicare
Because reverse mortgage payments are classified as loan proceeds rather than taxable income, they won’t affect Social Security or Medicare benefits. This makes them a valuable financial tool for retirees looking to supplement their income without triggering additional taxes or benefit reductions.
However, things can get complicated for those receiving needs-based benefits like Medicaid or Supplemental Security Income (SSI). If reverse mortgage funds aren’t spent in the same month they’re received, they might be considered an asset, which could impact eligibility for these programs.*
Capital Gains Taxes
Selling a home after having a reverse mortgage doesn’t change the standard capital gains tax rules. If you’ve lived in your home for at least two of the last five years before selling, you may qualify for a capital gains tax exclusion, up to $250,000 for individuals or $500,000 for married couples filing jointly.
This means that if your home has appreciated in value and you sell for a profit, you may be able to exclude a portion of those gains from taxation. However, if your home sells for less than the remaining loan balance, the lender absorbs the difference, and no capital gains taxes apply.
What Is the 95% Rule on a Reverse Mortgage?
Most reverse mortgages come with a non-recourse feature, meaning neither you nor your heirs will ever owe more than the home’s appraised value when the loan comes due. If the loan balance is higher than the home’s market value, FHA insurance covers the difference.
The 95% rule ensures that if your heirs want to keep the home, they can purchase it for 95% of its appraised value or the total loan balance, whichever is lower. This provides a level of financial protection, preventing your heirs from being stuck with a debt larger than the home’s worth.
Is It Hard to Sell a House With a Reverse Mortgage?
Selling a home with a reverse mortgage isn’t necessarily difficult, but there are some key steps to follow. Since a reverse mortgage is a loan, the balance must be repaid when the home is sold. If the sale price is higher than what’s owed, the remaining equity goes to you or your heirs.
If the home’s value has dropped below the loan balance, FHA insurance ensures you won’t owe more than the home’s worth. Your lender will provide a payoff amount, and you’ll need to work with a real estate agent familiar with reverse mortgages to handle the process smoothly.
With proper planning, selling a home with a reverse mortgage can be just like selling any other property.
What Is Negative About a Reverse Mortgage?
While a reverse mortgage can provide financial flexibility, it’s not without drawbacks. The loan balance grows over time since interest accrues, reducing the equity left for you or your heirs. You’re still responsible for property taxes, insurance, and maintenance, falling behind on these could lead to foreclosure.
Reverse mortgages also come with fees and closing costs, which can be higher than traditional loans. If you plan to move in a few years, this may not be the best option. It’s important to weigh the pros and cons carefully and consult a financial advisor before deciding.
How Do I Start the Reverse Mortgage Process?
A reverse mortgage can be a great way to turn your home’s value into extra cash, but it’s important to know how it fits into your bigger financial picture. While the money isn’t taxable, things like interest deductions and benefits eligibility can get tricky.
The good news? You don’t have to figure it out on your own. Rate makes it easy to explore your options and find the right fit for your needs. Ready to see how a reverse mortgage could work for you? Start your journey with Rate today.
*Consult a financial professional. Visit www.ssa.gov
This is not a commitment to lend. Reverse mortgages are eligible for borrowers 62 and older. Age limits for additional brokered loan options may start at 55. The borrower must meet all loan obligations, including living in the property as the principal residence and paying property charges, including property taxes, fees, and hazard insurance. The borrower must maintain the home. If the borrower does not meet these loan obligations, then the loan will need to be repaid. Otherwise, the loan must be repaid when the last borrower passes away or sells the home. Prices, guidelines and minimum requirements are subject to change without notice. Some products may not be available in all states. Subject to review of credit and/or collateral; not all applicants will qualify for financing. It is important to make an informed decision when selecting and using a loan product; make sure to compare loan types when making a financing decision. This material has not been reviewed, approved or issued by HUD, FHA or any government agency. Rate, Inc. is not affiliated with or acting on behalf of or at the direction of HUD, FHA or any other government agency. To find a Reverse Mortgage counselor near you, search the HECM Counselor Roster at https://entp.hud.gov/idapp/html/hecm_agency_look.cfm or call (800) 569-4287.
Charges such as an origination fee, mortgage insurance premiums, closing costs and/or servicing fees may be assessed and will be added to the loan balance. The loan balance grows over time, and interest is added to that balance. Interest on a reverse mortgage is not deductible from your income tax until you repay all or part of the interest on the loan. Although the loan is non-recourse, at the maturity of the loan, the lender will have a claim against your property and you or your heirs may need to sell the property in order to repay the loan or use other assets to repay the loan in order to retain the property. You should know that a reverse mortgage is a negative amortization loan which means that your mortgage balance will increase while your home equity decreases if you do not make principle and interest payments on your loan. This may make it more difficult to refinance the loan or to obtain cash upon the sale of the home. However, you will never owe more than the home is worth when the loan is repaid.
