When reviewing your retirement finances, finding that you’re rich in home equity and low in cash flow may mean looking into reverse mortgages and their alternatives. Because every borrower may not be a fit for each loan type, it’s critical to analyze all available financial options. To help you find the best match for your finances, here are explanations on reverse mortgages and their alternatives.
What Is a Reverse Mortgage?
A reverse mortgage is a loan for borrowers older than 62 where a percentage of the home’s equity is converted into usable cash. Through a payment plan, such as a monthly payment, lump sum or line of credit, the lender disburses the funds to the homeowner.
After a financial assessment, qualification process and counseling session, the borrower has access to 60 percent of the proceeds, and all funds after 12 months. Proceeds can be used for anything from living expenses and health care costs to paying off mortgages and debts.
“When consumers consider reverse mortgages based on advantages like no monthly mortgage payment, lump sum cash distribution, debt consolidation and monthly income distributions, it’s always important to confirm their goals,” says Noah Patterson, senior loan officer at Draper and Kramer Mortgage Corp. “Their goals dictate if a reverse mortgage is even the best option for them.”
Pros and Cons of Reverse Mortgages
Pros
— No monthly mortgage payments.
— Loan repayment isn’t required until the borrower sells, moves out or dies.
— Improves cash flow, and funds can be used for anything.
— Borrower remains in the home as long as insurance, property taxes and general maintenance are paid for.
— Because they’re nonrecourse loans, homeowners never owe more than the current home value, no matter how much is borrowed.
— If property value decreases, borrowers can still use up to the original loan amount, even if it’s more than the home’s updated value.
— At repayment, if the loan balance is less than the home value, you or your heirs keep the difference.
Cons
— Fees, closing costs and expenses can be high.
— Loan must be paid off immediately following homeowner’s death or move.
— Loan balance grows as interest accrues.
— Homeowners must still pay insurance, property taxes, homeowners association fees and keep the property in good condition.
— Homeowners lose equity over time.
[Read: How to Find the Best Reverse Mortgage Lender.]
Reverse Mortgage Fees and Expenses
Homeowners should expect to pay higher closing costs, plus origination fees up to $6,000. Unlike with refinancing, home equity loans or home equity lines of credit, reverse mortgage borrowers pay a counseling fee and possibly a monthly servicing fee; however, they usually don’t have to pay for processing or underwriting. Many fees are rolled into the total loan amount to minimize out-of-pocket expenses; however, this might decrease the total cash available.
“For the average reverse mortgage, you’re looking at $10,000 to $20,000 in closing costs,” says Daniel Marske, sales manager and home equity conversion mortgage specialist at BBMC Mortgage. “These FHA loans have a one-time upfront mortgage insurance premium fee, which is 2 percent of your principal limit.”
Additionally, a mortgage insurance fee of 0.5 percent of the total loan balance accrues annually and is paid off during repayment.
Reverse Mortgage Alternatives
Refinance mortgage (cash-out refinance). Refinancing may work if you’re looking to lower your payment. Not only do homeowners gain back monthly cash here, but you could get a lower interest rate. If you choose a cash-out refinance option, you gain a lump sum of your home equity. But you may have higher payments, because any cash extracted will be rolled into the new mortgage balance.
[Read: The Best Mortgage Refinance Lenders.]
“With a cash-out refi, which is getting a refinanced mortgage and extracting the available equity, you’re required to pay monthly on principal and interest,” says Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association. “You must also demonstrate available income to qualify. This recourse loan also means that regardless of property value, the borrowed amount must be paid back.”
Pros
— Good option if you have plenty of equity and don’t need quick money.
— Lower, fixed monthly payment that could be at a lower interest rate.
— Fees are lower than a reverse mortgage.
— Continues to build home equity.
— You still own your home and keep it as an estate asset.
Cons
— Have to make monthly mortgage payments and may pay more overall than with the original loan.
— For some borrowers, a refinance isn’t the best long-term choice, as the beginning payments are mostly interest, not principal.
— Money saved by refinancing could be too little to help with expenses.
— With closing costs and fees, upfront costs could be higher than other alternatives.
— Bank can foreclose on home if payments are missed.
Home equity line of credit. HELOCs are like home equity credit cards with a time limit: You can use up to your approved equity limit, and as you pay off the balance, more funds become available. However, at the end of this draw period, usually 10 years, the loan must be paid back, or you can refinance or extend the terms. Also, throughout the draw period decade, borrowers must continue to pay on interest.
“Once you get to that 10-year mark and the loan fully amortizes, you repay the balance over the next 20 years, but those who haven’t been diligent can be caught by surprise by the payment jumping substantially,” says Patterson.
Pros
— Lower fees and interest rates than a reverse mortgage.
— Draw period allows for payments on interest only.
— Access to cash on an as-needed basis.
— You pay interest only on the amount used, not on the entire loan amount.
— You still own your home, and it stays as an estate asset.
— Whatever is paid off is made available again like a credit card.
Cons
— You have to pay monthly on interest, and interest grows on the borrowed amount.
— After the draw period, your payments can increase drastically.
— Your home could be foreclosed on if you miss payments.
— Lenders can cancel your HELOC if your income or home value decreases.
— Your payment changes with fluctuating interest rates.
— If you plan to use little of the available credit, a HELOC’s upfront costs may not be worth it.
[Read: The Best Home Equity Loans.]
Home equity loan. A home equity loan allows you to borrow money in a lump sum, usually with a fixed interest rate, via the available equity you have in your home. If a reverse mortgage were intended to make a big purchase or pay off a large expense, this might be a better option; however, this loan requires immediate payback.
Pros
— Large amount of upfront cash.
— Lower fees than a reverse mortgage.
— Typically lower fixed interest rate than reverse mortgages.
— You still own your home, and it stays an estate asset.
Cons
— Immediate monthly payments to repay principal and interest.
— Your home could be foreclosed on if you miss payments.
— Less home equity is available for use.
— Usually costs more overall and has higher interest rates than other alternatives like a HELOC.
Selling. For some retirees, the best options may be selling and downsizing or selling the home to family in a sale-leaseback agreement.
Homeowners already interested in a smaller home or cheaper area may be able to use the sale proceeds to pay for a new home in cash or make a hefty down payment. Funds gained from selling can also be used to pay down debts or be used to help with moving expenses.
Those with good family relationships may also consider a sale-leaseback agreement. You could sell the home to family and either rent it back with the lump sum proceeds or have them pay you in monthly installments. Relatives gain rental income and an asset while you stay in the home.
Pros
— Provides funds to buy a more budget-friendly home in a cheaper area.
— Selling could mean extra cash to pay down various debts.
— Could allow for the cash purchase of a new home, meaning no mortgage payments.
— You could gain more cash from selling than with a reverse mortgage.
— Selling is typically cheaper than a reverse mortgage.
— Sale-leasebacks keep you in the home and could give relatives rental income.
Cons
— Selling could lead to a low sales price, which would reduce the amount of incoming cash.
— Selling may mean leaving the home, which would involve moving and possibly buying a new home.
— Selling to family could create tension.
— Family has to be able to qualify to buy the home.
— A family home sale should be reviewed by an attorney and tax advisor, which could raise the cost.
Renting. If you don’t need to make much cash and want to stay in your home, retirees might want to consider renting a room or their finished basement, or using their home as a vacation rental. The extra income is a plus, you may gain companionship and you could take monetary advantage of times when you’re already out of town.
Pros
— Keep your home.
— Increase income with regular rent payments.
— You may be able to rent to trusted family and friends.
— You could pay off the mortgage, or pay on property taxes or maintenance with extra income.
— If you travel frequently, you can make money while you’re away.
Cons
— Sharing space with renters, or you may have to vacate for vacation rental.
— Renters could present a variety of problems, such as property damage.
— Continually screening and replacing renters.
— Rental income must be declared as income on taxes.
Bankruptcy. In the event that you can’t qualify for a reverse mortgage or are struggling financially, Marske says declaring bankruptcy might be the right choice. “When we can’t get the reverse mortgage done, bankruptcy may make sense, because it helps seniors stay in their home and reduces monthly debts,” he says. “Depending on if they qualify, they can either wipe out their debt entirely or bundle all their debts in the one low monthly payment.”
Pros
— Usually can remain in the home.
— Eliminates debt or consolidates it into one lower monthly payment.
— Eventually there will be more available cash for monthly expenses.
Cons
— Lowers your credit score.
— Marks your credit history for about 10 years.
— May be more difficult to secure future financing, and that financing may include higher interest rates.
— Bankruptcy may have high costs.
How to Make the Best Decision
“Everything always boils down to the homeowner’s goals and needs,” says Marske. “Even though reverse mortgages can be a life-changing tool for some, it’s not the perfect fix for everything. Consumers should do their due diligence, educate themselves and they’ll see whether or not it’s the right loan for them.”
Making the best decision for you starts with determining where you see yourself long term. Asking these important questions upfront may clear up whether a reverse mortgage or an alternative works better for you:
— Do you want to stay in your home, or are you thinking of moving?
— Do you want to involve family members in your home decisions?
— Do you want the home to stay in the family?
— How do you plan to use the incoming funds?
“Homeowners have to consider if they’re in a position to make required monthly payments and if their retirement income will enable continued monthly payments,” says Irwin. “As we age, there are always unknowns, which can create shocks to retirement income streams, and having the proper financial safety net in place is important.”
More from U.S. News
Is a Portfolio Mortgage Right for You?
Should I Work With a Mortgage Broker?
Everything You Need to Know About Alternative Mortgage Lenders
Reverse Mortgage Alternatives originally appeared on usnews.com
