If you’re like many homeowners, at some point, you may find yourself in a position where most of your wealth is tied up in your home, a situation known as being “house rich cash poor.” While owning your own home brings you security and peace of mind, it can also leave you in a sticky situation if a financial challenge like an unexpected medical bill arises when you’re already making monthly mortgage payments.
When you don’t want to leave your home, but you need to find a way to convert your home equity, reverse mortgages and refinancing are two possible options.
Keep reading as we answer all your questions about a reverse mortgage vs. refinance, and whether either one is the right solution for you.
What Is the Difference Between a Reverse Mortgage and Refinancing?
A reverse mortgage is a loan that lets you borrow against the equity your home has accrued over time as you’ve paid off your traditional mortgage.1
Your home equity is its current market value minus any amount you owe on your mortgage and any liens on the property.2 A reverse mortgage lets you draw on this equity for living expenses or whatever other financial needs you choose, while remaining in your home.
Refinancing a mortgage means taking out a new loan that pays off the remaining loan balance on your existing mortgage.2 You may do this to get a lower interest rate, a lower monthly mortgage payment, or to borrow additional money. Refinancing can also be a smart choice for homeowners if they have an adjustable-rate mortgage and would prefer to change to a fixed-rate mortgage to protect against interest rate increases.3
Here are a few key differences between reverse mortgages and refinancing to keep in mind:3
- Reverse mortgages are only available to homeowners over age 62.
- A reverse mortgage lender gives you a payout based on the equity in your home but increases the amount you owe on your home over time.
- A mortgage refinance may or may not give you a payout, depending on the refinancing option you choose.
Pros and Cons of Reverse Mortgages
Let’s take a look at the pros and cons of reverse mortgages. Reverse mortgages can be an appealing solution for an older homeowner. There is no minimum credit score required to be eligible for a reverse mortgage, meaning you can get a reverse mortgage with bad credit.
There are three types of reverse mortgage loans: home equity conversion mortgages (HECM), proprietary reverse mortgages, and single-purpose reverse mortgages. Home equity conversion mortgages are backed by the Federal Housing Administration, and are the most common type of reverse mortgage.
These types of loans allow you to receive cash for your home’s equity as a lump sum, monthly payments, or a line of credit you can draw on as needed. You can stay in your home while benefitting from an extra income source.
That said, there are also some significant drawbacks to consider:
- The reverse mortgage loan must be paid back eventually.
- Reverse mortgage borrowers risk losing equity over time unless their home’s market value rises.
- The reverse mortgage loan comes due if you can no longer live in the home—for example, if you need to move into assisted living or want to move in with family.
- When the loan comes due, you or your heirs will typically need to sell the home to pay it off.
Pros and Cons of Refinancing
Now, let’s take a look at the pros and cons of refinancing. If interest rates dropped after you took out your mortgage, refinancing may allow you to take advantage of those lower rates. A mortgage refinance can also allow you to lower your monthly payments. For example, if your credit score has improved since you bought your house, you may now qualify for a lower-rate mortgage.3
Before you commit to refinancing, be sure to fully explore its potential disadvantages:
- You will have to pay closing costs and fees just as you did when you took out your previous mortgage, such as mortgage insurance premiums and credit report fees amongst others.2
- If your monthly payments are lower, it may be because your loan term has been extended over a longer period of time.2
- If your current mortgage has a prepayment penalty, you’ll need to weigh this cost against the monthly savings you expect to gain.3
Which is Right for You?
The appropriate solution for you depends on a variety of factors. First, you should take your age into account—remember, you can’t qualify for a reverse mortgage unless you’re over 62. You’ll also need to factor in any potential health issues that may cause you to leave your home within the next few years.
You should also consider:3,4
- The amount of equity in your home
- How long you’ve had your mortgage
- How much of your monthly mortgage payment is currently going toward the principal
- The fees associated with refinancing (mortgage insurance premiums, document prep fees, credit report fees, etc.)
- The circumstances that can cause a reverse mortgage to come due, requiring you to pay back the loan
Alternatives to Reverse Mortgages and Refinancing
As you’ve seen, reverse mortgages and refinancing each have their risks and drawbacks. If neither option feels right for you, there are other alternatives such as taking out a home equity loan or home equity line of credit. Another viable alternative to reverse mortgage loans for people who want to stay in their homes is a sale-leaseback program.
A sale-leaseback program lets you sell your house without sacrificing the security of staying in your home as a renter for as long as you’d like.
With many sale-leaseback programs, you can:
- Convert your home’s equity to cash, without the upheaval of moving out or the burden of taking out a loan
- Retain the option of buying back your home in the future
- Choose to re-sell the home to an outside buyer in the future, gaining any additional profit if the home has continued to appreciate
And if you’re trying to figure out how to get out of a reverse mortgage, selling a house with a reverse mortgage is possible through a sale-leaseback program as well.
Converting your equity while staying in the home that you love is the best of both worlds for many homeowners. If you’ve been considering a reverse mortgage vs. refinance, it’s important to take it slow, do your research, and keep in mind that these aren’t your only options for staying in your home.
- Consumer Financial Protection Bureau. Reverse mortgages: a discussion guide. https://files.consumerfinance.gov/f/documents/cfpb_reverse-mortgage-discussion-guide.pdf
- Consumer Financial Protection Bureau. Mortgages key terms. https://www.consumerfinance.gov/consumer-tools/mortgages/answers/key-terms/
- Federal Reserve Board. A consumer’s guide to mortgage refinancings. https://www.federalreserve.gov/pubs/refinancings/
- Consumer Financial Protection Bureau. You have a reverse mortgage: Know your rights and responsibilities. https://files.consumerfinance.gov/f/documents/cfpb_reverse_mortgage_rights_responsibilities.pdf
- Reverse Mortgage Information. Counseling. https://reverse.org/counseling