Confronted with increased expenses across various sectors such as fuel, groceries, credit card payments, and utility bills, a growing number of Americans are exploring avenues to secure additional funds. For homeowners possessing substantial home equity, two prominent options have emerged: reverse mortgage vs refinance.
These financial alternatives can serve as a lifeline for homeowners, enabling them to tap into the equity in their homes to address significant expenses or manage unforeseen financial burdens. However, it’s crucial to note that these options may not be suitable for everyone. Before committing, a thorough examination of the differences between reverse mortgages and cash-out refinances, how they operate, and who stands to benefit the most is advisable.
Key differences between reverse mortgage vs cash out refinance
A reverse mortgage is a form of loan that allows you to borrow against the accumulated equity in your home, which has grown over time through the repayment of your traditional mortgage. Your home equity is determined by subtracting the current market value of your home from the amount you owe on your mortgage and any existing liens on the property. With a reverse mortgage, you can access this equity to cover living expenses or address other financial needs while retaining residence in your home.
On the other hand, refinancing a mortgage involves obtaining a new loan to settle the outstanding balance on your existing mortgage. This may be done to secure a lower interest rate, reduce monthly mortgage payments, or obtain additional funds. Homeowners might opt for refinancing, especially if they currently have an adjustable-rate mortgage and wish to switch to a fixed-rate mortgage to guard against potential interest rate hikes.
It’s essential to note some key distinctions between reverse mortgages and refinancing:
- Reverse mortgages are exclusively available to homeowners aged 62 and above.
- While a reverse mortgage provides a payout based on your home equity, it also increases the amount you owe on your home gradually over time.
- A mortgage refinance may or may not result in a payout, depending on the chosen refinancing option.
Why it may be better to open a reverse mortgage
For homeowners lacking the necessary income to qualify for a loan that demands prompt repayment, such as a cash-out refinance, home equity loan, or HELOC, a reverse mortgage cash out emerges as a viable alternative. This option can prove advantageous, particularly for those with significant equity in their homes who require assistance in meeting day-to-day expenses. With a reverse mortgage, you can attain the financial support you need without the necessity of vacating your home.
Why may it be better to open a cash out refinance?
Opting for a cash-out refinance becomes favorable when prevailing interest rates are lower than those at the inception of your initial mortgage, potentially leading to savings in interest payments throughout the loan’s duration. This strategy is particularly sensible if you possess a stable income and can easily manage the associated payments. In contrast, a reverse mortgage stands out for not necessitating monthly payments, making it a preferred choice for many retirees.
Benefits and drawbacks of cash out refinancing
Let’s examine the advantages and drawbacks of refinancing. If interest rates have decreased since your initial mortgage, refinancing provides an opportunity to capitalize on these lower rates. Additionally, a mortgage refinance can enable you to reduce your monthly payments. For instance, if your credit score has improved since your home purchase, you may now qualify for a mortgage with a lower interest rate.
However, before committing to refinancing, it’s crucial to carefully consider potential downsides:
- Similar to when you secure your initial mortgage, refinancing incurs closing costs and fees, including items like mortgage insurance premiums and credit report fees.
- While your monthly payments may decrease, this could be a result of extending the loan term over a longer period, which may impact the overall cost of the loan.
- If your existing mortgage carries a prepayment penalty, you must weigh this cost against the anticipated monthly savings from refinancing.
Benefits and drawbacks of reverse mortgages
There are three primary types of reverse mortgage loans: Home Equity Conversion Mortgages (HECM), proprietary reverse mortgages, and single-purpose reverse mortgages. Among these, Home Equity Conversion Mortgages, or HECMs, are the most prevalent and are federally backed by the Federal Housing Administration.
These loan options empower you to access cash from your home’s equity in various ways, including a lump sum, monthly payments, or a line of credit that you can utilize as needed. This allows you to remain in your home while enjoying an additional income stream.
Nevertheless, it’s essential to be mindful of certain significant drawbacks:
- The reverse mortgage loan must be repaid eventually.
- There is a risk of diminishing equity over time unless the market value of your home increases.
- The reverse mortgage loan becomes due if you can no longer reside in your home, such as if you transition to assisted living or choose to live with family.
- When the loan becomes due, you or your heirs typically need to sell the home to settle the outstanding balance.
The bottom line about reverse mortgage vs refinance
For numerous homeowners, the prospect of converting equity while continuing to reside in their beloved home represents the ideal scenario. If you find yourself contemplating the choice between a reverse mortgage and a refinance, it is crucial to approach the decision methodically. Take your time, conduct thorough research, and remember that these options are not the exclusive avenues for maintaining your residence.