Reverse Mortgage vs Refinance: Which Is Better for You?
If you are a homeowner who wants to access some of the equity in your home, you may be wondering whether a reverse mortgage or a refinance is a better option for you. Both of these products allow you to borrow money using your home as collateral, but they have different features, benefits, and costs that you should consider carefully before making a decision. Here is a comparison of reverse mortgage vs refinance to help you understand how they work and which one may suit your needs better.
What Is a Reverse Mortgage?
A reverse mortgage is a type of loan that allows homeowners who are 62 years or older to convert some of the equity in their home into cash. Unlike a traditional mortgage, where you make monthly payments to the lender, a reverse mortgage pays you either in monthly installments, a lump sum, or a line of credit that you can access as needed. The amount you can borrow depends on several factors, such as your age, the value of your home, the interest rate, and the type of reverse mortgage you choose.
There are three main types of reverse mortgages:
• Home Equity Conversion Mortgages (HECMs), which are insured by the Federal Housing Administration (FHA) and are the most common and widely available type of reverse mortgages.
• Proprietary reverse mortgages, which are offered by private lenders and may allow you to borrow more money if you have a high-value home.
• Single-purpose reverse mortgages, which are typically offered by state and local governments or nonprofits and are designed for specific purposes, such as paying property taxes or home repairs.
The main advantage of a reverse mortgage is that it can provide you with extra income or cash flow without requiring you to make monthly payments or sell your home. You can use the money for any purpose you want, such as covering living expenses, medical bills, home improvements, or travel. You also get to keep the title and ownership of your home as long as you live in it as your primary residence, pay your property taxes and insurance, and maintain it in good condition.
The main disadvantage of a reverse mortgage is that it can reduce the amount of equity you have in your home over time, as interest and fees accumulate on the loan balance. This means that you may have less money left for your heirs or for other purposes when you sell your home or pass away. A reverse mortgage also has upfront and ongoing costs, such as origination fees, closing costs, mortgage insurance premiums, servicing fees, and interest rates, which can vary depending on the lender and the type of reverse mortgage you choose. Additionally, a reverse mortgage may affect your eligibility for certain public benefits, such as Medicaid or Supplemental Security Income (SSI), if it increases your income or assets above certain limits.
What Is a Refinance?
A refinance is a process of replacing your existing mortgage with a new one that has different terms and conditions. The new mortgage pays off the balance of the old one, and you start making payments to the new lender. The main reason why homeowners refinance their mortgages is to take advantage of lower interest rates and save money on their monthly payments. However, refinancing can also allow you to change other aspects of your mortgage, such as:
• The loan term: You can shorten or extend the duration of your loan, depending on your goals and preferences. For example, if you want to pay off your mortgage faster and save on interest costs, you can refinance from a 30-year loan to a 15-year loan. If you want to lower your monthly payments and free up some cash flow, you can refinance from a 15-year loan to a 30-year loan.
• The loan type: You can switch from a fixed-rate loan to an adjustable-rate loan (ARM), or vice versa, depending on how you expect interest rates to change in the future. A fixed-rate loan has the same interest rate throughout the life of the loan, which gives you stability and predictability in your payments. An ARM has an interest rate that changes periodically based on market conditions, which means that your payments can go up or down over time.
• The loan amount: You can increase or decrease the amount of money you owe on your mortgage by doing a cash-out refinance or a cash-in refinance. A cash-out refinance allows you to borrow more than what you owe on your current mortgage and receive the difference in cash. You can use this money for any purpose you want, such as paying off debt, investing, or making home improvements. A cash-in refinance allows you to pay down some of the principal balance of your current mortgage and reduce the amount of money you borrow on the new one. This can help you lower your interest rate, eliminate private mortgage insurance (PMI), or avoid negative equity.
The main advantage of refinancing is that it can help you save money on interest costs and monthly payments over time if you qualify for a lower rate than what you have on your current mortgage. Refinancing can also help you adjust your loan terms to better suit your financial situation and goals. For example, if you want to pay off your mortgage sooner or build equity faster, refinancing to a shorter term can help you achieve that. If you want to access some of the equity in your home or consolidate other debt, refinancing to a larger loan amount can help you do that.
The main disadvantage of refinancing is that it involves closing costs and fees that can add up to thousands of dollars. These costs include appraisal fees, title fees,
credit report fees, origination fees, points, and prepayment penalties. Depending on how much these costs are and how long you plan to stay in your home after refinancing, they may outweigh the potential savings from refinancing. Therefore, it is important to compare the break-even point of refinancing with your expected time horizon before deciding whether it is worth it or not. Another drawback of refinancing is that it resets the clock on your amortization schedule, which means that more of your payments will go toward interest than principal in the early years of the new loan.
How to Choose Between Reverse Mortgage vs Refinance
Choosing between a reverse mortgage and a refinance depends on several factors, such as:
• Your age: A reverse mortgage is only available for homeowners who are 62 years or older. If you are younger than that, refinancing may be your only option.
• Your equity: A reverse mortgage requires that you have significant equity in your home (usually at least 50%), while refinancing does not have a minimum equity requirement (although having more equity can help you get better terms). If you have little or no equity in your home, refinancing may be more feasible than a reverse mortgage.
• Your income: A reverse mortgage does not require that you have income or credit qualifications to qualify (although some lenders may check them), while refinancing does require that you have sufficient income and credit scores to meet the lender’s standards. If you have low income or poor credit history, a reverse mortgage may be easier to obtain than refinancing.
• Your goals: A reverse mortgage is designed to provide you with extra income or cash flow without requiring monthly payments or affecting your ownership of your home (as long as you meet the obligations), while refinancing is designed to lower your monthly payments or change other aspects of your loan terms (such as term length or type). If you need more money every month or want more flexibility in how you use it, a reverse mortgage may be more suitable for you. If you want to save money on interest costs or adjust your loan terms to fit your financial situation better, refinancing may be more suitable for you.
Ultimately, choosing between a reverse mortgage and a refinance depends on what makes sense for your unique circumstances and preferences. Both options have pros and cons that should be weighed carefully before making a decision. It is advisable to consult with a financial planner or counselor who can help you evaluate both options objectively and guide you through the process.
Summary
A reverse mortgage and a refinance are two ways for homeowners to access some of the equity in their home using their home as collateral.
A reverse mortgage pays homeowners who are 62 years or older either in monthly installments, a lump sum,
or a line of credit based on their age, home value, interest rate, and type of reverse mortgage they choose.
A refinance replaces an existing mortgage with a new one that has different terms and conditions based on the homeowner’s income, credit score,
equity level, interest rate,and type of refinance they choose.
Both options have advantages and disadvantages that depend
on various factors, such as the homeowner’s age, equity, income, credit, goals, and time horizon.
Homeowners should compare both options carefully and seek professional advice before deciding which one is better for them.