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
- 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.
- 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.
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.
“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.”
- 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.
- 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.