6 reverse mortgage alternatives
Carefully consider these options when thinking about a reverse mortgage
A reverse mortgage allows you to borrow against your home’s equity without making loan payments until you move, sell your home or die. While this option can help make retirement more affordable, it is not the best choice for everyone. Read on to explore alternatives to reverse mortgages and see what type of homeowner may benefit the most from each option.
- A reverse mortgage costs money to initiate, and you will have to continue paying taxes, insurance and other applicable fees.
- Consider alternatives to reverse mortgages when you need supplemental income or relief from mortgage payments.
- If you can secure a lower rate, a cash-out refinance is the best alternative.
What is a reverse mortgage?
A reverse mortgage allows you to borrow against your home equity and receive either monthly disbursements or one lump sum. Unlike a traditional loan, though, you and your family don’t have to worry about repayment until you move, sell your home or die. Typically, reverse mortgages are available for homeowners age 62 and older.
Reverse mortgages are not free money. You won’t make monthly payments to the lender, but you will still need to continue to pay for taxes, homeowners insurance and homeowners association (HOA) fees. The house must also be maintained according to the lender’s requirements. Failure to pay any of these costs could result in foreclosure. Additionally, getting a reverse mortgage comes with fees.
“There are several different [draw] plans and depending upon which is selected the amount of money received may vary, which may impact how effectively the reverse mortgage meets the borrower's financial goals,” said Jennifer Folk, chief operating officer at Minute Mortgage. “Be sure to understand how each of the different draw plans will fit with the financial goal before making a final determination on how to proceed.”
Pros and cons of a reverse mortgage
Before opting for a reverse mortgage, make sure you weigh the pros and cons.
- Stay in your home
- Supplement your retirement income
- Funds are tax-free
- Age restrictions
- Must own home outright or have low mortgage balance
- Risk of foreclosure
Alternatives to reverse mortgages
If you do not qualify for or want a reverse mortgage, there are still other options to help you tap into your home’s equity or lower your monthly mortgage bill.
1. Refinance your current home
Refinancing your home is one of the better alternatives to a reverse mortgage. By refinancing, you can potentially lower your interest rate, lower your monthly payment and withdraw cash against your home's equity.
It can be difficult to qualify for refinancing if you’re on a fixed income, but you can increase your odds of approval by working with your current lender or another bank you already have a relationship with. Make sure your credit history is accurate and that you've gathered proof of all your income sources, including Social Security, pensions, military benefits and any other regular sources of income.
Also, your home will need to be appraised. You can maximize your home's appraisal value by providing the appraiser with a list of permanent upgrades you've made to the property. This is a particularly important step if you want to borrow against the value of the home.
Pros and cons of refinancing your mortgage
- Can lower your monthly payment
- Can lower your interest rate
- Lets you cash out home equity
- Restarts your repayment term
- Higher long-term costs
- Closing costs and fees
Refinancing vs. reverse mortgages
Refinancing is ideal for taking advantage of your home equity if you have good to excellent credit. Unlike a reverse mortgage, you will still have your monthly mortgage payment, but if you secure a lower interest rate than when you first purchased your home, your monthly payments could be lower.
2. Take out a home equity loan
A home equity loan allows you to borrow against the equity in your home by taking out a second mortgage. This is a great option if you need an immediate influx of cash and can easily manage higher payments over a longer period of time. Remember that a home equity loan is secured by your property, which means your home can be foreclosed on if you can't repay the loan.
You can potentially borrow up to 85% of your home’s value, but home equity loans come with strict borrower requirements, such as a low debt-to-income (DTI) ratio and a credit score of 620 or higher.
Pros and cons of a home equity loan
- Access to cash
- Fixed interest rate
- Tax deductible for home improvements
- Raises monthly payments
- Secured by your home
- Closing costs and fees
Home equity loans vs. reverse mortgages
Home equity loans allow homeowners to use their equity, but it can be hard to qualify for the loan. Additionally, this option comes with fees and increases your monthly mortgage payment. If you are struggling to afford your mortgage, a reverse mortgage would relieve your monthly payment obligation.
3. Use a home equity line of credit (HELOC)
Similar to a home equity loan, a home equity line of credit (HELOC) allows you to borrow against the value of your home. However, instead of providing a lump-sum payment, a HELOC gives you access to a revolving credit line (like a credit card). Once you repay your balance, you can reuse the available credit. You repay (with interest) only what you borrow, not the entire credit line. Many lenders only require you to make interest-only payments during the five- to 10-year draw period.
Pros and cons of a HELOC
- Revolving credit access
- Pay only what you withdraw
- Interest-only payments during draw period
- Variable interest rate
- Secured by your home
- Potential for overborrowing
HELOCs vs. reverse mortgages
If your goal is to have extra money for an emergency fund or home improvements, a HELOC gives more flexibility than a reverse mortgage. Some reverse mortgage lenders give the option for a line of credit as the payout method; a reverse mortgage is more likely to have a fixed rate than a HELOC, which often comes with a variable rate.
4. Sell and downsize your home
In some cases, keeping your home may not be the best financial decision. Selling and downsizing to a more affordable mortgage is a way to alleviate this financial burden. In some cases, the equity you have in your home may be enough to buy a more affordable home outright.
Some homeowners see selling as an opportunity for adventure and a change of scenery, while others may be reluctant to leave the place they've called home for many years. Consider your needs, the value of your home and how much you owe on your mortgage to determine if this approach is right for you.
Pros and cons of selling your home
- Cash from the sale
- Lets you adjust your housing to your needs
- Potential change of scenery
- Lifestyle adjustments
- Sentimental attachment to home
- Home may need updates before selling
Selling your home vs. reverse mortgages
A reverse mortgage allows you to stay in your home without the stress of making monthly mortgage payments. Your name remains on the title, but you will need to repay the loan when a repayment event occurs. When you sell your home, you are able to keep any profits, but you will also need to find a new place to live.
5. Renting out your house
If you live in an area where rental properties are in demand, renting out your home can be a great way to obtain extra income and reduce your financial burdens. This is a good option if you can't or don’t want to sell your home.
Check rental rates in your area for comparably sized homes to see if this makes financial sense for you. Keep in mind that you'll be responsible for maintenance issues and disputes with tenants. If you don't have the time or energy to deal with these issues, you can hire a property manager to handle them for you.
Pros and cons of renting out your home
- Extra income
- Maintain ownership of home
- Potential change of scenery
- You have to relocate
- Stress of having tenants
- Maintenance costs
Renting out your home vs. reverse mortgages
Both renting and a reverse mortgage are ideal solutions when you aren’t sure if you want to sell your home. By renting out your home, you are able to generate money that can be used toward mortgage payments and other bills. However, you will also need to report that income as tax and find a different place to live. A reverse mortgage’s disbursements are classified as loan proceeds, not income.
6. Filing bankruptcy
Bankruptcy can stay on your credit for up to 10 years.
If you’re considering a reverse mortgage to get out of financial trouble, bankruptcy is also an option. A bankruptcy can stay on your credit for up to 10 years, but the effects on your credit score may not affect you much if you don't intend to take out loans in the future. Likewise, if you're relying on Social Security, veterans benefits or other retirement income, your financial life may be largely unaffected by filing for bankruptcy.
Bear in mind that some debts cannot be wiped away by filing for bankruptcy, including most student loans, child support, alimony and other secured debts.
Bankruptcy should always be a last resort, though, even for older adults. If you own your home, your property and other assets may be sold to pay off any outstanding debts. However, most states have a homestead exemption that allows you to keep your home as long as your equity doesn't exceed your state's limits.
Pros and cons of filing for bankruptcy
- Eliminates debts
- Older adults may have reduced consequences
- Can keep home in most cases
- Hurts your credit score
- Assets may be sold to pay debts
- Not all debts qualify
Bankruptcy vs. reverse mortgages
Bankruptcy can devastate your financial well-being and should be considered as the last possible option. While you might be able to remain in your home after bankruptcy, there is a risk you will not. Every financial move you make will be affected by bankruptcy for the next decade. A reverse mortgage is a less risky move to alleviate financial stress, and you can always refinance or sell your home if you want to get out of the loan.
What alternatives to reverse mortgages are right for me?
If you're considering a reverse mortgage, carefully think about your current financial situation, your future needs and the details of your home to decide whether one of the above alternatives is worth pursuing.
- If you need long-term budget relief, refinancing, renting or selling your home may be better options.
- If you need a quick influx of cash but can manage higher monthly payments, home equity loans or lines of credit are worth checking out.
- Only consider bankruptcy as a last resort if you have a high DTI ratio and aren’t confident in your other options.
A reverse mortgage may end up being the right choice for you. What’s important is that you make an educated decision and know all your options before you commit.
Who should not get a reverse mortgage?
Not everyone will qualify for a reverse mortgage because of age and equity restrictions. Those who do qualify should weigh the choice carefully because reverse mortgages can come with costs and risks. You should not pursue a reverse mortgage if you:
- Want extra funds but have the means to repay additional payments: A cash-out refinance, home equity loan or personal loan would be a better option.
- Cannot afford to pay taxes, insurance or other fees: A reverse mortgage can remove your monthly mortgage payment, but you will still need to afford other house costs and maintenance.
- Want to pass on your home without issue: Your heirs will be the most affected by a reverse mortgage if you pass away. They will need to repay the loan to keep the home. If they cannot, they will need to sell it or forfeit it to the lender.
How do you repay a reverse mortgage?
The reverse mortgage repayment becomes due when you move, sell the home, die or fail to meet lender requirements. You can also repay your reverse mortgage at any time. If you cannot afford to pay off your reverse mortgage outright, you can refinance it back to a traditional mortgage.
Why don’t banks recommend reverse mortgages?
Reverse mortgages have costs and risks that make them a bad fit for some older homeowners. For some, they are the ideal tool to supplement retirement income. For others, they can have harmful long-term effects on estate planning.
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