How Does a Reverse Mortgage Work With a Trust?

A reverse mortgage allows homeowners to access their home equity without selling their property, often providing financial relief in retirement. When a home is held in a trust, additional considerations impact eligibility and loan terms. Understanding these factors is essential for those seeking a reverse mortgage while maintaining estate planning benefits.

This article explores key aspects of using a reverse mortgage with a trust, including qualification requirements, tax implications, and what happens when the borrower passes away.

Reverse Mortgage Essentials

A reverse mortgage is a loan available to homeowners aged 62 and older, allowing them to convert a portion of their home equity into cash without monthly payments. Unlike a traditional mortgage, where borrowers make payments to a lender, a reverse mortgage provides funds to the homeowner, with repayment deferred until they move out, sell the home, or pass away. The most common type is the Home Equity Conversion Mortgage (HECM), insured by the Federal Housing Administration (FHA) and regulated by the U.S. Department of Housing and Urban Development (HUD).

Loan proceeds can be received as a lump sum, monthly payments, or a line of credit. The amount available depends on the borrower’s age, home value, and interest rates. Older borrowers typically qualify for higher loan amounts. The home must be the borrower’s primary residence, and they must continue paying property taxes, homeowners insurance, and maintenance costs to avoid default.

Trusts in Real Property Ownership

Holding a home in a trust is a common estate planning strategy that helps homeowners manage their property during their lifetime and after their passing. A trust is a legal arrangement in which a trustee holds and manages assets on behalf of beneficiaries according to the grantor’s instructions. This structure helps avoid probate, provides asset protection, and establishes clear directives for property distribution.

Revocable living trusts are commonly used for real estate ownership because they allow the grantor to retain control over the property and make changes as needed. This flexibility ensures the homeowner can refinance, sell, or transfer the property without significant legal hurdles. In contrast, an irrevocable trust removes ownership rights from the grantor, placing control entirely in the hands of the trustee. While this can shield assets from creditors or reduce estate tax exposure, it also limits the homeowner’s ability to make changes without trustee approval.

Lenders reviewing a reverse mortgage application for a trust-held property require a thorough review of the trust agreement. The trust must allow the homeowner to serve as both the beneficiary and trustee, ensuring they maintain authority over the property. If the trust restricts the homeowner’s rights in a way that conflicts with loan requirements, modifications may be necessary. Lenders may also require a legal opinion letter from an attorney confirming compliance with lending rules.

Qualifying for a Reverse Mortgage With a Trust

Lenders assess whether the trust structure aligns with loan eligibility requirements. The borrower must remain legally and financially responsible for the home. If the trust agreement restricts the homeowner’s ability to take out a loan or encumber the property, it may need to be amended. Some lenders require the home to be temporarily removed from the trust, allowing the reverse mortgage to be placed in the homeowner’s name before deeding it back into the trust post-closing.

Beyond trust-specific considerations, borrowers must demonstrate the ability to cover ongoing property expenses, including taxes, insurance, and maintenance. Lenders conduct a financial assessment to determine if the applicant has sufficient income or assets to meet these obligations. If concerns arise, a portion of the loan proceeds may be set aside in a “Life Expectancy Set-Aside” (LESA) account to cover these costs, reducing the risk of default.

Estate Transfers Upon the Borrower’s Passing

When a borrower with a reverse mortgage held in a trust passes away, the loan becomes due. The trustee or designated successor must determine how to satisfy the outstanding balance, as lenders typically require repayment within six months, though extensions may be granted. If beneficiaries wish to keep the home, they must repay the loan through refinancing or other assets. If repayment is not feasible, the property may be sold, with any remaining equity distributed according to the trust’s terms.

If the home’s value has declined and is worth less than the loan balance, federal protections under the HECM program prevent heirs from being personally liable for the shortfall. The lender can only recover the lesser of the loan balance or 95% of the home’s appraised value, with the FHA covering any remaining loss.

Fees and Tax Liabilities

Securing a reverse mortgage while holding a home in a trust introduces various costs and tax considerations that borrowers and their beneficiaries should evaluate.

Loan Costs and Fees

Reverse mortgages come with several upfront and ongoing costs. The initial mortgage insurance premium (MIP) for HECMs is typically 2% of the home’s appraised value, up to the FHA lending limit. Borrowers also pay an annual MIP of 0.5% of the outstanding loan balance. Other costs include origination fees, which can be as high as $6,000 depending on the home’s value, as well as appraisal, title insurance, and closing costs. Since the home is held in a trust, legal fees may arise if modifications are needed to align the trust with lender requirements.

Tax Implications

Reverse mortgage proceeds are not considered taxable income by the IRS because they are loan advances rather than earnings. This means they do not impact Social Security or Medicare benefits. However, if funds are invested and generate income, that income may be taxable. Property tax obligations remain unchanged, and failure to pay them can result in loan default. If the home is sold to repay the loan, capital gains tax may apply if the sale price exceeds the original purchase price plus allowable adjustments. Beneficiaries inheriting a home with a reverse mortgage may benefit from a step-up in basis, potentially reducing capital gains taxes if they sell the property.

Repaying the Reverse Mortgage Balance

Once the borrower no longer resides in the home, the reverse mortgage must be repaid. The repayment process depends on whether the borrower moves, sells the home, or passes away, and the trust structure can influence how the loan is settled.

If the home is sold, the proceeds first go toward repaying the loan, with any remaining equity distributed according to the trust’s terms. If the loan balance exceeds the home’s value, the non-recourse nature of HECM loans ensures that neither the borrower’s estate nor heirs are responsible for the shortfall. Beneficiaries who wish to keep the home must either refinance the loan into a traditional mortgage or pay off the balance using other assets. Lenders typically allow up to six months for repayment, with two potential three-month extensions if efforts to sell or refinance are actively underway.