July 1, 2004
If you're like many Americans, your house is your largest single asset, and it's been appreciating at a rate that probably outstrips your investment portfolio. In fact, your home might represent a good portion of your retirement fund. But, can you afford to sell, and then retire?
You can no longer be certain that you can avoid capital-gains tax when you sell a house and move. Under the current rules, every time you sell your house, you could owe taxes. Single filers can exclude $250,000 of gains on every sale, and married taxpayers filing jointly can exclude $500,000. You can take that deal every two years.
But what about those who stayed put for many years and watched their homes soar in value? Even a million-dollar profit dwindles when a single person can exclude only $250,000 of gain. And depending on where you live, you might also owe state and local taxes.
How reverse mortgages work
So if you're thinking of your family home as a significant part of your retirement fund, your best solution might be a reverse mortgage, which allows you to withdraw those gains tax-free as long as you live.
A reverse mortgage is available to people over age 62 who have paid off their mortgage or have only a small balance left.
The amount of money you can withdraw is determined by the value of your home, your age, and the current level of interest rates. For example, today a 65-year-old with a home appraised at $200,000 could get a monthly check for $614 for life. A 75-year-old could get $829. You could also take a lump sum, or just establish a line of credit based on your home equity.
If you want to calculate what you could receive from the sale of your home, either in monthly payments or a lump sum, go to www.reversemortgage.org and use the online calculator. That same Web site will also give you a list of reverse mortgage lenders in your area.
There are limitations on the home value that can be accessed through reverse mortgages, depending on location. For example, in Chicago, the cap on equity that can be withdrawn via an FHA-insured reverse mortgage is $237,500. Fannie Mae also has a separate Home-Keeper reverse mortgage, with a cap that is slightly higher.
One company, Financial Freedom (888-REVERSE), offers jumbo reverse mortgages for homes valued over $450,000. It has several programs, including a no-fee option.
Reverse mortgage loans are made through participating banks, and regulated by the federal government. In fact, in order to take out a reverse mortgage, seniors are required to go though independent counseling to make sure they understand the facts. Counseling can be obtained through AARP, and is designed to make sure seniors understand their options.
If you take the monthly check option, you're effectively turning your home equity into your pension. The idea of taking money out of your home scares many seniors. They worry that they can exhaust their equity and that their home will be taken away. But you can never run out of money with a reverse mortgage -- even if you live far longer than the statistics predict! As long as you, or your co-owner spouse, live in the home, you'll get that monthly check if you chose that option. If you enter a nursing home for a while, or spend the winter in Florida, you don't have to worry about your house being sold out from under you.
When you die, or move and sell your house, the bank is repaid out of the proceeds. The bank gets back what they paid to you, plus a rate of interest that floated over the life of the loan. If there's no equity left, the bank doesn't go after your estate. It's repaid the remaining balance through an FHA guarantee. If there's excess cash left after the loan is repaid when the house is sold, the money goes to you or your heirs.
There's a cost to all this. The FHA takes a fee of 2 percent of the property value, up to the lending limit. And there is an origination fee of less than $2,000. These fees can take a bite out of the lump sum or monthly check you will receive. You wouldn't have that expense if you just took out a home-equity loan. But then, you'd be expected to repay a home-equity loan, unlike the case with a reverse mortgage.
So, if you're house-rich and cash-poor, and don't want to give your profit to Uncle Sam, a reverse mortgage may be just the answer. That's the Savage Truth.
This is not a commitment for a loan or an ad for credit as defined by paragraph 226.24 of regulation Z.