Over the course of homeownership, money may get tight. People lose jobs, seniors live on a fixed income, and of course, we’ve seen how challenging it has been for people to get by during the pandemic. If you’re a homeowner finding yourself needing some extra money, you have options.
With a standard mortgage, you borrow money and pay the lender back in monthly payments. A reverse mortgage is the opposite--the lender pays you (a lump sum, monthly payments, a line of credit, or a combination of the three), and the loan is paid back years later via the ultimate sale of the house. This loan doesn’t need to be paid back for as long as you live in the house, which allows you to keep the title and continue living in your home. But if you sell, pass away, fail to pay property taxes and insurance, or move out for over a year, the loan is due. Except the lender can’t sell the home until the borrower’s living spouse passes away or until one of the aforementioned examples happens.
And ultimately, when the home is sold, the lender keeps the proceeds to cover what they paid to you, with the remaining equity/money from the sale going to you/your surviving heirs. Over the course of the loan, interest accumulates and your equity decreases, because the lender buys more and more of your home. Reverse mortgages tend to be costly with high closing costs and fees over the life of the loan. And you should keep in mind that, as time goes on and the bank owns more of your home, there may not be much equity left for your children to inherit. This means the home isn’t really an asset for you.
Interest grows over time and is added to your monthly balance. Most reverse mortgages have variable rates, which means that interest rates may change. Interest is not tax-deductible until you pay the loan off. And since you keep the title, you are responsible for all home maintenance, utilities, taxes, and other expenses. Failure to insure or maintain the home could result in a foreclosure or the lender requiring you to repay the loan. And you should keep in mind that not having much equity could be an issue if you need money from the sale of the house to pay for a nursing home or other eldercare.
To qualify for a reverse mortgage, you must be 62, and you must own your home outright or have a small remaining balance on your mortgage. There is no income requirement, but there can’t be any other liens or loans on the home.
Single-purpose reverse mortgages - Offered by nonprofits and local/state government agencies, this is generally considered to be the least expensive reverse mortgage. But the lender can require that the loan be used for a single purpose only, like home repairs. Most homeowners, regardless of income, can qualify for this type of loan.
Proprietary reverse mortgages - These are private loans. Homeowners with high-value homes may get a larger loan advance.
Home Equity Conversion Mortgages (HECMs) - Backed by the Department of Housing and Urban Development (HUD), this federally insured reverse mortgage can be used for any purpose you choose.
A reverse mortgage may be the better option if you are at least 62 years old, own your home outright or have a small mortgage balance; you are retired, on a fixed income, and looking for the source of long-term income to maintain your lifestyle; you will “age in place” and stay in your home for the remainder of your life; you are cash poor but equity rich; and if you are OK with your home not being part of your estate to pass on to your children.
Similar to a reverse mortgage, this option lets you use your home equity to get money. But it’s much more like a standard mortgage than a reverse mortgage. That’s why it’s actually called a second mortgage. With a home equity loan, the lender gives you a lump sum which you pay off (with fixed-rate interest) in regular monthly installments until the loan is paid.
With this option, your home is an asset for you and your heirs, as you retain your equity and pass the home onto your children. But it also means that your home is collateral, so you can face foreclosure and lose it if you default on your loan.
There is no age requirement to qualify for a home equity loan, but you need at least 20% equity in your home. And you will need a good credit score and a stable income. You are required to pay interest on the full loan amount, which is tax-deductible (for years 2018-2025), but only if the money is used for qualified purposes--building, buying, or improving your home.
A home equity loan may be the better option if you are under 62 but still need/want to use your equity to cash in; you are looking for short-term money, can make monthly payments, and prefer to keep your equity in your home; you are employed with a stable income; you want the tax benefits from repaying the loan.
There is also a lesser-known third option, the HELOC. Much like a standard credit or debit card, a HELOC allows you to withdraw up to a certain credit limit as needed. You pay it back monthly based on your interest rate and the amount you borrow. With a HELOC, instead of paying interest on the full loan amount (like for a home equity loan), you only pay interest on the amount you withdraw. But the interest rate is variable and can change, so you won’t always know what your next payment will be.
Just like with home equity loans, the interest is tax-deductible only if the money is used for the qualified purposes mentioned above. The HELOC also has no age requirement, but you must have 20% equity, a good credit score, and a stable income.
A HELOC may have lower costs, interest, and fees, but it’s also riskier than the other options. The lender can cut you off and require full repayment at any time. And if you can’t repay it, that means you’ll likely need to sell the home. This is really only a good option if you are going to stay in the home for a short time.
So which loan is the right loan for you? There are positives and negatives to each option. A reverse mortgage costs more but provides long-term security and doesn't need to be paid back until the homeowner dies or the home is sold, vacated, etc... A home equity loan gives the borrower more money in the short term but requires monthly payments that might be a challenge for seniors on a fixed income.
It goes without saying that you should meet with your financial advisor, attorney, and/or accountant to discuss the right path for you. But you should always educate yourself nonetheless, and we hope we helped you do that. And please, beware of reverse mortgage scams.
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