Exiting a Reverse Mortgage

A Guide for Advisors and Families

If one of your clients is considering a reverse mortgage, or perhaps they already have one in place, the plan doesn't stop when the loan is funded. In fact, like nearly every financial product, setting it up is only the beginning; managing it is where the value is extracted. And while we've discussed many of the management strategies during the life of the loan - making payments, allowing the line to accumulate, supplementing long term care insurance, purchasing a home, and many others, the focus for this writing will be on exiting a reverse mortgage.

What happens at the end of the loan?

The question isn't whether the loan will end; it's whether the family is prepared when it does. The exit strategy from a reverse mortgage isn't simply about paying off a loan; it's about preserving options, reducing confusion, and helping families make thoughtful decisions during an emotional time.

The Biggest Misconception

Ask someone on the street what happens at the end of a reverse mortgage and you might hear the same answer, “The bank gets the house.” It isn't true.

A reverse mortgage is still a mortgage. The homeowner retains title to the property throughout the life of the loan, just as they would with a traditional mortgage. They remain responsible for property taxes, homeowner's insurance, and maintaining the home. When the loan eventually becomes due, the home becomes part of the owner's estate, not the lender's. In fact, like with other loans, the lender doesn't want the house, they simply want to be repaid according to the terms of the loan. However, there are some differences based on the nature of the reverse mortgage.

When Does a Reverse Mortgage Become Due?

One of the most common reverse mortgages is the FHA insured Home Equity Conversion Mortgage (HECM). These (and most other types of reverse mortgages) generally become due and payable when one of several events occurs:

• The last surviving borrower passes away.
• The home is sold.
• The borrower permanently leaves the home, generally for more than 12 consecutive months for health care.
• The home is no longer the borrower's principal residence.
• Certain loan obligations, including property taxes, homeowner's insurance, or property maintenance, are no longer met.

While the timing of these events could be unexpected, the fact that they could occur should not come as a surprise.  They should already be incorporated into the family's retirement and estate plan.

What Should the Family Do First?

One piece of advice solves a surprising number of problems. Contact the loan servicer immediately.

Families wait. They assume there's plenty of time, or they'd rather not deliver the news just yet. Understandable. Also potentially expensive.

Here's the actual clock: HUD generally gives the family six months from the due-and-payable notice before the servicer must begin foreclosure.  This may be extendable, with HUD approval, up to 12 months total. Sounds generous until you remember that window has to cover probate, sibling negotiations, listing the house, and finding a buyer. Twelve months disappears fast when four adult children are involved and only one of them returns calls.

The servicer can explain documentation, extension requests, payoff procedures, and the options actually on the table. The sooner that call happens, the more of those twelve months the family spends on purpose instead of by accident.

The Family Has Choices

Most families are unaware of the options available to them. Depending on goals and circumstances, they may choose to:

• Sell the home.
• Refinance into a traditional mortgage to keep the property.
• Pay off the loan with available assets.
• Sign the property over through a deed in lieu of foreclosure: walk away, owe nothing beyond the home itself.
• Utilize the HECM's nonrecourse protections if the loan balance exceeds the property's value.

This is where advisors provide tremendous value: helping families weigh every option, instead of allowing something to happen to them or defaulting to whatever the neighbor down the street did with their late mother's house.

Understanding the Nonrecourse Protection

Suppose the home is worth $500,000 but the reverse mortgage balance has grown to $575,000. Many families immediately worry they'll need to write a check for the $75,000 difference. Generally, they won't. Because a HECM is a nonrecourse loan, neither the borrower nor the heirs are personally responsible for an allowable deficiency if the home's value is less than the loan balance. Likewise, heirs who wish to retain the home may generally satisfy the loan by paying the lesser of the outstanding balance or 95% of the current appraised value, provided HUD requirements are met. This protection is one of the most consumer-friendly features of the HECM program and one of the least understood.

The Tax Document Too Many Families Throw Away

After the loan is repaid, the servicer issues a Form 1098.

Most families glance at it, shrug, and file it in the junk drawer with the expired coupons and the remote that goes to nothing. Mom's gone. Dad's gone. Why would the IRS care now?

Because the IRS always cares.

Here's the part almost nobody explains well: accrued reverse mortgage interest isn't deductible while it's accruing. It becomes deductible (maybe) the moment it's paid. Payoff is often that moment.

“Maybe” is doing a lot of work in that sentence.

The IRS doesn't care that the loan was a reverse mortgage. It cares what the money was used for. Interest only qualifies if the draws bought, built, or substantially improved the home. That's acquisition debt. Everything else, the supplemental income, the medical bills, the grandkids' tuition, the cruise, is home equity debt. And home equity debt interest hasn't been deductible since 2018. Congress made that permanent this year, so you can stop waiting or hoping for it to come back.

Translation: if the HECM funded a kitchen remodel, there's a real deduction sitting in that 1098. If it funded twelve years of groceries, there probably isn't, no matter how big the number looks. This also suggest that homeowners need to be advised to maintain all records associated with these improvements.  It’s also worth noting that if the reverse mortgage was used to refinance a previous mortgage, if those original loan proceeds qualify as acquisition indebtedness, they will maintain that characteristic with the new loan. 

There's also a ceiling. Interest is only deductible up to $750,000 of qualifying acquisition debt. Most clients won't bump into it, some will, worth noting.

The timing also matters. One thing to keep in mind is that the deduction needs to be used in the year in which the interest was paid.  One of the tricky things with timing is that in most cases, servicers won’t send the 1098 until after the first of the year.  So if you don’t know you have a deduction available until February, and the deduction is only good for the previous year, what if you didn’t have sufficient taxable income to be able to use the deduction?  This is where you can provide some extremely valuable advice.

To claim the full deduction, you might want to pair the deduction with a deliberate taxable event.  This could be a Roth conversion, an IRA distribution already on the calendar, or a lump sum distribution based on capturing the deduction.  This one-time deduction offsets a one-time tax bill. That's not a loophole. That's just timing. Which is most of what good planning actually is.

Consider a client who drew $150,000 over the years, all of it for home improvements.  They added a new roof, a kitchen, an accessibility renovation. At payoff, accrued interest on that portion came to $62,000, fully qualifying as acquisition debt. Her advisor timed the payoff to land in the same year as a $50,000 Roth conversion. The deduction offset a meaningful chunk of the resulting tax bill. That's not an accident; that's a strategic plan.

None of it works if nobody kept track of what the money was for.

Encourage your clients, while they can still remember, to keep it simple. 

Document these items:

• Draw amount
• Date
• What it was used for
• Keep receipts!

Three columns. Not glamorous. Possibly worth tens of thousands of dollars to whoever inherits the paperwork.

This is not a DIY moment. Coordinate with the family's CPA before the payoff, not after the 1098 shows up in a shoebox. The deduction doesn't file itself, and “I think it might be deductible” is not a tax strategy.

Don't Wait Until It's Too Late

Picture the call. Nine PM on a Tuesday, three weeks after the funeral. An adult child stands in a kitchen that isn't theirs yet, holding a letter from a servicer they've never heard of, trying to figure out if they've inherited a house or a problem.

That call is preventable. Almost entirely.

Perhaps the greatest planning opportunity has nothing to do with the loan itself. Whenever possible, encourage clients to talk to the people who'll eventually inherit this responsibility. That doesn't mean sharing every dollar figure over Thanksgiving dinner. It means eliminating the surprise.

Children should understand why the loan exists, what their options will be, and who to call first. Skip that conversation, and heirs make emotional decisions about an unfamiliar financial product during the worst weeks of their year. Nobody does their best thinking under those conditions. That's not a flaw in the family; it’s just how grief works.

Questions Every Advisor Should Ask

Before a reverse mortgage ever reaches its conclusion, ask...

Do the heirs even know this loan exists...

Does anyone actually want to keep the house, or do they just feel like they should...

Would keeping it make financial sense, or only emotional sense...

Are all the heirs aligned, or are three people quietly planning three different outcomes...

Is there enough liquidity in the estate to keep every option open...

How were the proceeds actually used...

Has the CPA seen this coming, or are they about to find out in April...

Are the attorney, the CPA, the advisor, and the reverse mortgage professional working from the same plan, or four different ones...

These conversations often become just as valuable as the original retirement planning itself.

Final Thoughts

The best retirement plans don't simply solve today's challenges; they anticipate tomorrow's decisions. Reverse mortgages, or any other financial strategy, should not be a surprise to the family; they should be communicated at the right time. Families that communicate experience smoother transitions, especially during emotional events. The family home may be one of the most emotionally charged assets in an estate. Prioritizing understanding of options and encouraging family communication is a critical role for advisors to play in earning generational trust and family continuity.

If you’d like to learn more about reverse mortgage exit strategies and other aspects of integrating home equity into retirement planning, check out our events and resources at www.EquityWealthStrategies.com.