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5 Questions You Should Be Asking Beyond the Financial Assessment
Lately there have been several media accounts stating that much confusion remains for HECM borrowers including a recent article in Nerd Wallet by MJ Knoblock. I have to admit I have some healthy skepticism when the media claims that reverse mortgages are still confusing for borrowers especially since the Home Equity Conversion Mortgage mandates counseling to cover the basic mechanics of the loan. Nevertheless the article does warrant the question, am I asking the right questions?
Here are just a few questions we should consider when meeting with a prospective borrower.
1- Are you currently itemizing deductions on your taxes such as mortgage interest? As the Financial Assessment pushes us toward the ‘mass affluent’ we should be aware that the elimination of mortgage interest payments could bump the borrower into a higher tax bracket. While not giving tax advise we should most certainly inform them that no longer making mortgage payments could effect their deductions if they are itemizing and perhaps place them in a higher tax bracket. In my experience the benefits of the HECM typically far outweigh the slight increase in taxes due but encourage them to seek the advice of a tax professional.
2- Property taxes and insurance. Many perhaps did not ask but we must with the Financial Assessment. Seize upon the opportunity to educate the borrower that failure to pay property taxes and insurance in a traditional mortgage would result in foreclosure just as it would with a reverse mortgage. This risk is not unique to the HECM.
3- Spending plan. We should always ask the borrower if they have a strategy…
Download a transcript of this episode here.
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4 Comments
With regards to the point on mortgage interest and itemized deductions;
If the primary purpose for securing a reverse mortgage is to eliminate the payment of principal and interest, the borrower is way ahead cash flow wise by not having to make this payment than the lost tax deduction should they itemize.
And for the vast majority of borrower’s that did opt to do this, the incremental tax liability would most likely be at the same tax rate if they had continued with the interest from their forward mortgage.
Mr. Theiss,
Please see below.
Good presentation Shannon!
John
Mr. Theiss,
Be careful with your advice. While in the past, our primary target audience was the house rich/cash poor/needs based 72 year old retired widow, times have changed. In yesteryear, your statements had considerably more validity than today. Not only is the product different today but so are the demographics of our customers and their interest tax situations. Many believe that those demographics and income tax situations will only change more with time
A higher percentage of those getting HECMs today are still working with the expectation that a significant if not substantial portion of their employment compensation will be replaced by Social Security a few years after getting the HECM. Since Social Security is largely non-taxable, it is generally expected that those borrowers will drop from moderate income tax rates to the lower ones.
What your comment shows no understanding about is the use of a HECM in a tax plan. When interest tax benefits warrant such planning, accrued interest on the HECM can still be paid and is a great idea when the HECM is an adjustable rate HECM since the cash used to pay down the accrued interest can be recovered later through the line of credit. Not only that but the borrower increases his/her cash position by lowering the income tax due. However, if the borrower has a fixed rate HECM, the amount used to pay down the accrued interest will not be recoverable (due to no line of credit) until the HECM is fully paid off so all the borrower will be doing is using up cash even if the income tax benefits today will be greater than when the accrued interest would otherwise be paid.
Further, current payment of accrued interest to gain annual deductions may in fact be a poor decision in comparison to the possibly larger benefits that bunching could result in. Also the interest deduction rules do not necessarily result in all interest paid being deductible. Those rules must be carefully analyzed to determine how much of the paid interest is deductible and what type of interest deduction they result in.
Also be aware that there is a specific application order to the paydown on a HECM. Generally, all cash received will be applied first to MIP, then service fees and property charges, interest, and finally principal. The order of the application will generally mean that more cash will be required to pay down the desired amount of accrued interest (up to the total accrued) than the amount of accrued interest that is desired.
Rather than advising customers in a field you obviously have little experience with, you should be ADVISING them to seek the counsel of a tax adviser who is not only competent, experienced, and knowledgeable but also one who understands how to put a HECM to its best and highest use.
(The opinions expressed in this comment are not necessarily those of RMS or its affiliates.)