Your home is likely your most valuable asset – and if you’re looking for an alternative to a reverse mortgage so you can tap into that value without risking everything, you’ve come to the right place.
Using the value of your home in a reverse mortgage is a common method that many people use to generate cash. Though a popular way to get cash income quickly with no monthly mortgage payments, it isn’t always the best option for everyone.
Depending on your situation, you may want to consider some alternatives to a reverse mortgage such as a home equity line of credit or home equity loan, a 401(k) distribution, and others.
In this guide, we’ll discuss everything you need to know about a reverse mortgage, as well as some alternatives to reverse mortgage that are worth considering.
What is a Reverse Mortgage?
A reverse mortgage is designed for adults who are older, generally 62 years of age or older. This type of loan allows you to borrow against your home equity in order to receive a fixed monthly payment or a line of credit (or a combination of both). You’re essentially borrowing money from the value of your home.
The repayment of the loan is deferred until you sell your home, move out, become delinquent on insurance or property taxes, the home falls into disrepair, or you die. Once your home is sold, the excess after the reverse mortgage is repaid goes directly to you or to your heirs.
Reverse mortgages can be extremely complicated and if not done correctly, can be problematic. It’s important to pay careful attention to the details of the loan, especially if you are married and want to be able to pass the house on to beneficiaries later on.
Why You Might Consider a Reverse Mortgage
Reverse mortgages can be beneficial in several ways.
You might consider applying for one if you want quick cash to pay off your existing mortgage, to supplement your income, or pay for healthcare expenses. This will let you convert your home equity into cash without having to sell your home or pay for additional monthly expenses.
That said, there is a lot to be wary about here. We’ll discuss some of the more problematic aspects of reverse mortgages below, but before you shop around for loans, ask yourself some key questions. To avoid falling for wily sales pitches and make sure a reverse mortgage is right for you, ask yourself the following questions first:
- Will the reverse mortgage be used to pay for property taxes or home repairs that can’t be covered in any other way?
- Is your home of a high value?
- Can you get a loan with decent closing costs, interest rates, and minimal servicing and origination fees?
- Do the total costs and loan repayment terms make sense?
- Will you receive a lump sum payment?
Generally, the older you are, the more equity you have in your home, and the less you owe on it, the more money you can get out of a reverse mortgage.
3 Types of Reverse Mortgages
Not all reverse mortgages are alike. Here are the three main types to be aware of.
Single-Purpose Reverse Mortgage
This is the least expensive type of reverse mortgage. Offered by local and state agencies as well as nonprofit organizations, they aren’t available everywhere. They can only be used for one purpose – for example, if you get your reverse mortgage to pay for home repairs, it can’t be used to pay for property taxes.
Often, you have to have a low income in order to qualify for this sort of loan.
Proprietary Reverse Mortgage
A proprietary reverse mortgage is a private reverse mortgage that is funded by a company. These kinds of loans are meant for high-value homes.
Home Equity Conversion Mortgage
Also known as HECMs, Home Equity Conversion Mortgage loans can be more expensive than traditional home loans and they have high upfront costs. However, they’re federally insured and allow you to choose among numerous payment options, including a combination of monthly payments and a line of credit.
When (and Why) is a Reverse Mortgage a Bad Idea?
A reverse mortgage isn’t necessarily a bad idea, but there are several reasons to be wary – and to consider alternatives to a reverse mortgage first, before you dive in.
First, remember that there are fees and other costs associated with applying for a reverse mortgage. You’ll be charged an origination fee, closing costs, and servicing fees. You may also be charged a mortgage insurance premium.
As you get money from your reverse mortgage, you’ll have interest added on to your principal each month. It grows as the interest of your loan builds up over time.
Not only that, but most reverse mortgages have variable interest rates. These change with the markets and on the plus side, give you more options as to how you get your money, but as a negative, could end up costing you much more money than you anticipated.
The interest that builds on a reverse mortgage, unlike other types of interest debt (such as student loans) is not tax-deductible, either. You’ll have to pay additional costs related to your home since you’re still in possession of the title – things like property taxes, insurance, homeowners insurance, utilities, and more. If you don’t pay your bills, your lender might require you to start repaying your loan immediately.
It’s important to communicate with your family if you plan on taking out a reverse mortgage. In some situations, as long as your spouse pays insurance and taxes, he can continue to live in the home if you’ve died. However, if he wasn’t part of the initial loan agreement, he won’t get any more money from the reverse mortgage.
Finally, reverse mortgages can use up all the equity in your home, meaning fewer assets left over for your heirs – and for you.
Alternatives to Reverse Mortgage
Fortunately, a reverse mortgage is not your only option if you’re struggling to figure out how to make ends meet. Here are some good alternatives to how you can tap into your home’s equity to get some extra cash.
Refinance the Existing Mortgage
Refincinaging your existing mortgage is a good way to lower your monthly mortgage payments and free up some cash. Especially if it’s been a while since you took out the original mortgage balance and your credit score has improved, refinancing is a good idea to help you save some money over the life of your loan.
Pursue a Home Equity Loan
A home equity loan (or second mortgage), will allow you to borrow money by taking advantage of the equity you have in your home. You’ll get the loan as a single lump-sum payment – you can’t draw additional funds from the house after that.
The benefit of this type of loan is that the interest is deductible up to $100,000 – even if you use the loan for a higher-risk purpose like student loans or credit card debt. If your loan was used for a qualified purpose (such as to improve the primary residence) you can deduct up to $1 million.
Take Out a Home Equity Line of Credit
Often confused with a home equity loan, a home equity line of credit is a bit different. You won’t be paying interest on the entire loan amount regardless of whether you use it – instead, you’ll pay interest just on the amount of money that you actually pull out during the draw period.
Sell or Downsize
While this alternative might not work well if you want to stay in your home, this is a good alternative if you want some extra retirement income or are interested in shopping around for a more affordable home with possibly a lower mortgage.
As long as you’re willing to move, selling your house and downsizing to a smaller one is a good way to get some extra money in your pocket.
Get a Renter
You might be able to make sufficient income just by renting out a portion of your home to a tenant. The downside to this, of course, is that you’ll lose a bit of privacy in your home.
Apply for Property Tax Relief
If you’re interested in a reverse mortgage because you are afraid you are going to miss payments for property taxes, you might want to apply for property tax relief before you sign the paperwork on a reverse mortgage. Call the assessor’s office to find resources for low-income seniors. You might be able to have your property tax payments waived or postponed.
Take a 401(k) Loan or Distribution
It’s risky to tap into your retirement income when you’re young, but in some cases, it can be better than a reverse mortgage.
If you won’t face penalties for early withdrawals, consider tapping into your 401(k) plan.
Sell to Your Kids
If you want to sell your home but have some family members that are resisting this decision, you might want to consider selling the house to your kids. There are a variety of options you can pursue here, too, including a sale-leaseback agreement in which you sell the house then rent it back using the cash from the sale.
Your child can perform the role of “landlord” so that they get the rental income – and they’ll be able to take deductions for depreciation, maintenance, property tax payments.
The Bottom Line: Alternatives to Reverse Mortgage
If you’re short on cash and only have your home equity to tap into, you might think that a reverse mortgage is your only option. For many homeowners, however, that’s not the case.
Of course, you’ll only be eligible for this kind of agreement if you own your home or are close to paying it off. You have to have enough equity that a reverse mortgage will give you a large enough lump sum to make it worth the effort.
Keeping up with your homeowner’s insurance, property tax payments, and home maintenance are all essential if you have a reverse mortgage. If you are able to do these three things, don’t plan on moving, and don’t have any plans to bequeath your home to family members, then this kind of loan might be a good idea for you.
Otherwise, consider some of the other alternatives to a reverse mortgage instead.