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Reverse mortgage basics: From taxes to catches

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  • Reverse mortgage payments are not considered taxable income.
  • Reverse mortgages do not affect Social Security or Medicare benefits but can impact Medicaid and SSI eligibility.
  • Potential risks include foreclosure and the accumulation of fees and interest, which can reduce home equity.

As seniors look for ways to supplement their retirement income, reverse mortgages often come up as a viable option. These financial products allow homeowners aged 62 and older to convert part of their home equity into cash without having to sell their home or take on additional monthly payments. However, while reverse mortgages can be beneficial, they come with their own set of tax implications and potential risks that seniors need to be aware of.

A reverse mortgage is a loan that allows senior homeowners to access the equity in their homes. Unlike traditional mortgages, where you make monthly payments to the lender, a reverse mortgage pays you. The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA). According to Kiplinger, "You retain title and ownership of your house. You are still responsible for paying the property taxes and the costs of insurance and repairs".

Tax Implications

One of the most attractive features of a reverse mortgage is that the money you receive is not considered taxable income. As Investopedia notes, "The reverse mortgage payments that you receive are loan advances—not income. This means that you won’t owe any income taxes on the money you receive from your lender". However, you can only deduct the interest on a reverse mortgage if the loan proceeds are used to buy, build, or substantially improve your home.

Impact on Government Benefits

While reverse mortgage income does not affect Social Security or Medicare benefits, it can impact eligibility for other programs like Medicaid and Supplemental Security Income (SSI). "If the homeowner wants to receive benefits from Medicaid, their eligibility will be based on both their income and their assets. Income from a reverse mortgage won't count against them, but if they received a lump sum from the reverse mortgage, that will be included among their assets".

Potential Risks

Despite the benefits, reverse mortgages come with several risks. One significant risk is the potential for foreclosure. If you fail to pay property taxes, homeowners insurance, or maintain the home, the lender can foreclose on the property. As Investopedia points out, "Failure to do so can allow the lender or loan servicer to foreclose on the property and cost the borrower their home".

Another risk is the accumulation of fees and interest over time, which can significantly reduce the equity in your home. This can leave little to nothing for your heirs. Kiplinger warns, "There are costs associated with a reverse mortgage, interest and fees, that accumulate during the term".

Reverse mortgages can be a valuable tool for seniors looking to supplement their retirement income. However, it's crucial to understand the tax implications and potential risks involved. Always consult with a financial advisor to determine if a reverse mortgage is the right choice for your financial situation.

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