With this post, I’d like to examine a couple aspects of reverse mortgages that receive little attention in the media, and from lenders: building code violations (and the resulting fines) and tax deductions. The latter is a plus, as it means the true cost of a reverse mortgage is actually lower than the stated cost. The former, however, is is a serious detriment, which could potentially lead to foreclosure.

Neither of these aspects is unique to reverse mortgages. The tax deductibility of mortgage interest is frequently cited by those within the industry as a great benefit, since it means your true cost of interest is lowered by your marginal tax rate. For example, if you pay 35% tax on your income, then the true amount of interest you pay on your mortgage is 35% less than the amount you pay the lender each month, with the difference “subsidized” by the government.

The same applies to reverse mortgages, although conceptually it’s a bit more complicated. That’s because reverse mortgages are often obtained by borrowers that have no intention of directly repaying them. Rather, the expectation is that the borrower’s heirs will handle the repayment after his death. Thus, it’s conceivable that no mortgage interest (or principal for that matter) is paid by the borrower, and hence no tax benefit can be realized.

Still, borrowers ought to be aware that their heirs can deduct the accrued mortgage interest when it ultimately repaid, perhaps after the house is sold. There are also complex estate planning strategies designed to maximize the benefit of the tax deduction. For example, the future heirs may wish to repay a certain amount of interest each year (prior to the loan being repaid) in order to spread the tax deductions over a longer time period of time.

Another option is to use a reverse mortgage to take out a special insurance plan, the proceeds of which will be received upon the death of the borrower. Assuming the insurance policy and reverse mortgage are congruent, this method will effectively turn an asset that would otherwise have been subject to estate taxes and make it un-taxable. Of course, these strategies are extremely complex and it’s recommended that your seek legal counsel, rather than proceed on your own.

The other side of reverse mortgages that I want to explore in this post is the consequence of not maintaining the property that has been mortgaged. Again, just like with conventional mortgages, unpaid property taxes and/or unpaid fines resulting from maintenance violations can result in foreclosure. This is a potentially serious pitfall for seniors that either didn’t have much equity in their properties to begin with, and/or spent the balance of the reverse mortgage too quickly, without setting aside enough cash for maintenance and property taxes.

Reverse mortgage lenders love to point out that there is only one contingency that can result in the property being foreclosed upon. Unfortunately, this is a very serious contingency, especially when you consider that the product is designed for borrowers with precarious financial situations. If your home declines in value and/or the balance of the loan cannot be repaid, it is HUD (via its insurance arm) that is on the hook for the difference. If you don’t keep up with your taxes, or you rack up too many building code violations, the state could put a lien on your home and force an immediate sale of the property. This could leave with very little money for you to put towards a new place to live.

The importance of this consideration cannot be overstated. Make sure that prior to taking out a reverse mortgage that you have enough funds set aside to maintain the property as before. Otherwise, it may make sense to downsize into a more affordable home.

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