The numbers certainly are impressive. Americans age 65 years and older now total 32 million. Of these, three-quarters own their own homes, and nearly two-thirds of them own their homes free of any mortgage. Total home equity of older Americans approaches $700 billion, representing a tremendous financial resource. But recent surveys show 86% of older homeowners want to remain in their homes for life. As a result, more Americans are asking their CPAs the same question: How can we tap some of this equity without leaving the home we love? This article considers one available option-the reverse mortgage.
With reverse mortgages, owners borrow against the equity in their residences and defer repayment until some time in the future. Beyond this simple description, reverse mortgages vary widely in their key features depending on state law and local practice. Loan duration, borrower eligibility, repayment schedule, interest rate, size of loan and disclosure requirements all are important variables. (See the sidebar on page 39 for a description of some of them.)
Some uniformity may result, however, from the recent Federal Housing Administration (FHA) announcement of a tenfold expansion of its reverse mortgage program. This program's features are of particular interest to practitioners because of the program's national scope.
In general terms, FHA-insured reverse mortgages are available to people who are at least 62 years old and live in single-family dwellings that comply with local building codes. The amount that can be borrowed depends on the home's value, the borrower's age, prevailing interest rates and local housing cost averages. Many rural areas, for example, have a maximum loan amount of $67,500, while in other areas the FHA will lend up to $124,875 (1992 limits).
FHA mortgages, moreover, are of the life tenure type; that is, borrowers need not repay the loan until they die or move out of their mortgaged residences (perhaps to nursing homes). This feature contrasts with the more conventional fixed-term arrangement, under which monthly payments are sent to homeowners for a stipulated period of time and the total of those payments, plus interest, are due at the end of the period.
The life tenure concept obviously is more attractive to older homeowners because it speaks directly to the biggest emotional obstacle to tapping their homes' equity--a fear of outliving this equity and being forced to leave their homes before they are ready to do so. Clients who choose this option typically receive smaller monthly payments than those with fixed-term mortgages, but they have the security of knowing they will not be dispossessed.
INCOME TAX CONSIDERATIONS
At first glance, reverse mortgages seem to generate few tax considerations. The loan proceeds are not taxable, regardless of the payout schedule. Nor is the interest deductible by most homeowners, who typically report on the cash basis and accordingly have no deductions until the entire loan is repaid. Even then, interest is deductible only as home equity indebtedness to the extent the loan's principal does not exceed $100,000. Many reverse mortgages exceed that threshold.
The major income tax issue involves the $125,000 exclusion of gain on principal residences sold by homeowners at least 55 years of age. This is the same group that generally is eligible under the various reverse mortgage programs. The gain exclusion, of course, is familiar to most CPAs, particularly tax practitioners.
Although both reverse mortgages and the tax exclusion require minimum ages for eligibility, the tax exclusion also has an explicit home-use requirement. This requirement generally is three of the last five years, with an exception added in 1988 that counts time spent in a licensed nursing home toward the three-year requirement.
As a practical matter, homeowners who do not satisfy …