A reverse mortgage is a loan for homeowners who are 62 and older who want to convert part of the equity in their home into cash (usually tax-free). The borrower keeps the title of the house and is still responsible for paying property taxes, utilities, home insurance, maintenance, and other related costs. It can be a great option for homeowners who are low on income and savings but have plenty of equity in their home. However, they are not for everyone. As you can see in the graph below, their popularity has dropped since 2009. This article provides a detailed analysis of the alternatives to a reverse mortgage.
While a reverse mortgage makes sense for some retirees, not everyone will be able to qualify for one.
First, one homeowner must meet the age requirement. That part is simple. You must also live in the home. It can’t be a rental property.
Another key factor for qualifying is having enough equity in your home. You need quite a bit of equity to qualify for a reverse mortgage. Ideal candidates have paid off their home loans completely or have a very small remaining balance. Even if you do qualify for a reverse mortgage, it may not be the best option for you.
The main alternatives to a reverse mortgage are home HELOCs, cash-out refinance loans, and selling or renting your property. Let’s look at the pros and cons of each option.
Home equity line of credit (HELOC)
Kenneth Er, Senior Sales Associate at Compass in the Bay Area, suggests a HELOC as one alternative to the reverse mortgage. A HELOC is a second mortgage on your home that gives you access to a set amount of cash.
The amount is based on the equity in your home. Typically, you are allowed 85% of your home’s value minus the balance remaining on your mortgage.
Here is a list of the benefits and the drawbacks to consider when comparing HELOCs and reverse mortgages.
- You don’t need to have as much equity as you do for a reverse mortgage.
- You only pay interest on the cash you end up withdrawing and using.
- There is typically an annual account maintenance fee, but it’s pretty minimal.
- Retirees on a limited income may not qualify for a HELOC.
- Unlike a reverse mortgage, you will have to make a monthly payment on a HELOC.
- You risk losing your home if you can’t pay back the loan.
A cash-out refinance is taking out a larger loan to pay off your existing mortgage. You’ll then use the rest of the loan as cash in hand. People sometimes refer to this as using your home as a piggy bank.
It’s similar to refinancing your home loan, except that, instead of getting a new mortgage equal to the one you already have, you are taking out a larger loan with new terms.
Er says these types of loans are often used for “getting a lump sum for a trip, remodeling, or a child or grand child’s college tuition.” However, a cash-out refinance can be an alternative to a reverse mortgage as well.
Here is a list of the benefits and the drawbacks to consider when comparing cash-out refinancing and reverse mortgages.
- According to Er, you get the best rate since it will be on a conventional mortgage.
- The money can be used for anything you want.
- You don’t have to pay taxes on the cash you take out.
- You can still write off interest payments.
- You lose equity in the home.
- You could end up underwater.
- The more you borrow, the more interest you end up paying, which can add up in the long run.
- You will have to make monthly loan payments, possibly a higher amount than you’ve been paying.
Sell the home and buy something smaller – or just rent
Sometimes the best thing to do is to downsize or rent, particularly if your home’s value has greatly increased. If you have a lot of equity, you can sell the existing property, purchase something smaller, and keep the cash difference.
Er adds, “In certain counties in California, you can transfer your property tax base so, even though the homeowner may be buying a property for more, their property tax rate will be the same. This only works with people over 55 years old, in participating counties, and you can only do this one time.”
Here is a list of the benefits and the drawbacks to consider when comparing renting or selling and reverse mortgages.
- You could end up with a large amount of cash leftover, which you can use any way you choose.
- You can simplify your life by living in a smaller home or renting.
- There is no loan to worry about paying back.
- In some states, there will be a one-time tax advantage, as Er explains above.
- You may have a sentimental attachment to your home.
- Not every state will offer a tax advantage, so your property tax may rise.
- Your home may not be worth enough for you to buy or rent another home to your liking.
Alternatives to a reverse mortgage | Start your research
If you’re a retiree who is in need of greater cash flow, start looking into the variety of options available to homeowners.
If you own a home and have some equity, there are options out there for you, even if a reverse mortgage isn’t right for you.