Understanding reverse mortgage insurance premiums
If you elect a Home Equity Conversion Mortgage (HECM) insured by the Federal Housing Administration (FHA) as your reverse mortgage of choice, one of the upfront and ongoing costs you will incur is a Mortgage Insurance Premium (MIP).
Reverse mortgage insurance serves two purposes. First, it protects the lender from the risk of loaning more to a homeowner than what is ultimately repaid at the end of the reverse mortgage.
Reverse mortgage loan amounts are based partially on the life expectancy of the borrower(s). There is also an expectation that the home will increase in value during the life of the loan. If the borrower lives longer than expected and/or the property does not appreciate in value, the total amount borrowed could exceed the home’s market value when it’s time for the borrower to repay the reverse mortgage.
Reverse mortgages are non-recourse loans, meaning that only the value of the home and no other assets can be used to repay the loan. So if the homeowner’s reverse mortgage balance, including loaned funds, interest, and fees, totaled $250,000, but the home could only sell for $200,000, the lender would be on the hook for the remaining $50,000. However, with an FHA-insured HECM, the lender can collect the $50,000 shortfall by filing a claim on the mortgage insurance.
The second purpose of reverse mortgage insurance is to protect the borrower in the event the lender goes out of business. The FHA insurance would continue making monthly payments to the borrower and/or keep the line of credit open.
Even though reverse mortgage insurance is primarily designed to protect the lender, the borrower is charged the premium. All FHA reverse mortgages are charged an initial MIP at closing. The amount depends on your first-year disbursement.
If you receive less than 60 percent of the loan amount in the first year, the initial MIP will be 0.5 percent of the appraised value of your home, up to $625,000. If you plan to receive more than 60 percent of the loan amount, the MIP will equal 2.5 percent of the appraised value of your home, up to $625,000.
So, for example, if your home is appraised at $400,000 and your first-year disbursement is less than 60 percent of the total loan amount, your upfront MIP will be $2,000 ($400,000 x .5% = $2,000). If your first-year disbursement is above 60 percent of the total loan amount, the upfront MIP will total $10,000 ($400,000 x 2.5% = $10,000).
Borrowers also pay an annual MIP for the life of the loan equal to 1.25 percent of the outstanding mortgage balance. You will not pay this premium during the life of the loan. Instead, like your reverse mortgage interest, it will accrue over time and be part of the overall repayment amount when the reverse mortgage ends.
One way to think about the ongoing MIP cost is to add the 1.25 percent premium to the loan interest rate. Therefore, if the interest rate in a particular year is 3 percent, you will actually be paying 4.25 percent on your reverse mortgage balance because of the insurance requirement.
Since they are not federally insured, single-purpose and proprietary reverse mortgages typically will not require the payment of mortgage insurance. That doesn’t necessarily mean these loans will cost less. You may pay a higher rate of interest or higher fees than what would be charged on an HECM.
Therefore, it’s important for prospective reverse mortgage customers to shop around for the best overall rates and charges.
Are mortgage insurance premiums tax deductible
Mortgage insurance premiums are only considered tax deductible if they are part of a home acquisition; they can not be deducted on home equity loans.
That means that only HECM for Purchase reverse mortgages, in which you are financing the purchase of a home using a reverse mortgage, allow for deductible mortgage insurance premiums.
Also, you can only take the deduction in the year you pay the premium. So if you paid the upfront MIP at closing, you could deduct that amount. But you cannot deduct the annual MIP that accrues on the loan unless you pay the premium in that tax year.
There are also income limits that determine whether a homeowner can or cannot deduct mortgage insurance premiums.