The reverse mortgage has been proposed as an extraordinary approach to retirement income generation. This approach amounts to converting the accumulated equity in one’s home at retirement into a fixed income annuity.
The attractiveness of this manoeuvre is that the retiree will not have to pay as long as he/she lives in the home.
One early query was whether the income generated from the reverse mortgage would be subjected to income tax. The answer is no. The income results from a financial rearrangement of one’s assets.
During one’s working years, one would have accumulated net ownership in one’s home through regular payments of the mortgage. In retirement, one would just be arranging to get that ownership back in a different form.
It may have been possible to claim part of the mortgage interest as a deduction against taxable income during the years when paying the original mortgage. Yet, that will not affect the non-taxable status of the equity which would have accumulated.
Furthermore, there is no capital gains tax. So, even any additional equity arising from the capital appreciation of the property over the life of the mortgage can also be accessed tax-free.
Another important query was about the upfront costs of the reverse mortgage. And, yes, there are upfront costs like any mortgage – such costs as the commitment fee, fees for valuing the property, mortgage insurance and so on.
However, the emphasis is on getting cash income into the retiree’s hands. So, the retiree can ask for all fees and charges to be rolled into the computation of the annuity payment. These costs would then be just netted off the proceeds of the reverse mortgage loan before assessing the monthly annuity amount payable.
Should the retiree holding a reverse mortgage have a change of heart, the home can still be sold. However, the retiree would have to repay the mortgage in full and obviously relinquish that residence to the new purchaser (or pay rent to the purchaser).
In addition, if the retiree decides to move out of the home permanently, the reverse mortgage terminates, and the mortgage becomes payable just like a normal mortgage. The retiree may prefer the option of selling the home, and receiving the net proceeds rather than having to repay the loan when he/she moves out.
The retiree may then rent alternative accommodation. This may be a wise approach where the property gains significant capital appreciation during the period of the reverse mortgage.
Some enterprising retirees may opt for a lump sum rather than settle for a monthly annuity. Enterprising because such a retiree is likely to be of the high risk nature such that he undertakes to invest part of the lump sum.
That is because taking a lump sum virtually implies that the retiree is expecting to accumulate a higher return than the mortgage interest rate by investing the lump sum. That is the only way this would make economic sense.