Using the equity in your residence is a method that many people use to raise cash. A homeowner may use several methods to tap into this income vein, but some may be better suited than others.
One popular option—which often fills the airwaves with commercials—is the reverse mortgage. While popular, however, this may not be the best choice for many homeowners. Here, we consider some alternatives.
- A reverse mortgage is a type of loan for seniors ages 62 and older that allow homeowners to convert their home equity into cash income with no monthly mortgage payments.
- While these products are designed to create retirement income from home equity, they may not be the best solution for everyone.
- Alternatives that you may want to consider are traditional cash-out mortgage refinances, second mortgages, or sales to family members, among others.
If you’re age 62 or older, you may be able to convert the equity in your home into cash with a reverse mortgage. This loan lets you borrow against the equity in your home to get a fixed monthly payment, a line of credit, or some combination of the two. Repayment is deferred until you move out, sell the home, become delinquent on property taxes or insurance, the home falls into disrepair, or you die. Then the house is sold, and any excess after repayment goes to you or your heirs.
Reverse mortgages can be problematic if not done correctly and require careful attention to the rights of the surviving spouse if you are married or intend to pass the house on to your beneficiaries.
Of course, the end of the process means that you or your heirs give up your home unless you are able to buy it back from the bank. Unscrupulous lenders can also be a risk, so choose this option carefully and only after you have done your due diligence.
1. Refinance Your Existing Mortgage
If you have an existing home loan, you may be able to refinance your mortgage to lower your monthly payments and free up some cash. One of the best reasons to refinance is to lower the interest rate on your mortgage, which can save you money over the life of the loan, decrease the size of your monthly payments, and help you build equity in your home faster.
Another perk is that if you refinance instead of getting a reverse mortgage, your home and the equity that it builds remain an asset for you and your heirs.
2. Take Out a Home Equity Loan
Essentially a second mortgage, a home equity loan lets you borrow money by leveraging the equity that you have in your home. It works the same way as your primary mortgage: You receive the loan as a lump-sum payment, and you cannot draw any additional funds from the house.
Previously, interest paid on home equity loans and home equity lines of credit (HELOCs) was tax deductible. However, the 2017 Tax Cuts and Jobs Act narrowed the eligibility for a home equity loan deduction. For tax years 2018 through at least 2025, you will not be able to deduct interest on a home equity loan unless that loan is used specifically for the qualified purposes described above. It also dropped the level at which interest is deductible to loans of $750,000 or less.
A home equity loan is generally fixed-rate, which provides security against rising interest rates. Because of that, the interest rate is typically higher than for a HELOC. As with refinancing, your home remains an asset for you and your heirs. Because your home acts as collateral, it’s important to understand that it is at risk of foreclosure if you default on the loan.
3. Take Out a Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) gives you the option to borrow up to your approved credit limit on an as-needed, or revolving, basis. Unlike a home equity loan, where you pay fixed interest on the entire loan amount whether you’re using the money or not, with a HELOC, you pay interest only on the amount of money that you actually withdraw. HELOCs are adjustable-rate loans, meaning that your monthly payments will change as interest rates fluctuate.
The rules about tax deductibility and qualified purposes are the same as for a home equity loan described above. A HELOC retains your home as an asset for you and your heirs. Nevertheless, as with a home equity loan, your home serves as collateral and could be foreclosed if you default.
4. Sell Your Home or Downsize
The options above keep you in your existing home. However, if you’re willing and able to move, selling your home gives you access to the equity that you have built.
This option may be especially appealing if your residence is larger than you currently need, is too difficult or costly to maintain, or has prohibitively expensive property taxes. The proceeds can be used to buy a smaller, more affordable home or to rent, and you’ll have extra money to save, invest, or spend as needed.
5. Sell Your Home to Your Children
Another alternative to a reverse mortgage is to sell your home to your children. One approach is a sale-leaseback agreement, in which you sell the house and then rent it back using the cash from the sale. As landlords, your children get rental income and will be able to take deductions for depreciation, real estate taxes, and maintenance.
Another approach is a private reverse mortgage, which works like a reverse mortgage except that the interest and fees stay in the family. Your children make regular payments to you, and when it’s time to sell the house, they recoup their contributions (and interest).
It’s not free to set up this type of arrangement, but it is typically much cheaper than getting a reverse mortgage through a bank, and the home remains an asset for you and your children. Selling to your children has tax and estate planning ramifications, so it’s important to work with a qualified tax specialist or attorney.
6. Sell Off Other Assets
If the primary reason why you are considering taking out a reverse mortgage is to access cash, then you may be able to access cash cheaper via other means. You may have other assets that you can sell.
If you have a car that you are no longer using very frequently, look into transportation programs for seniors in your area and determine if selling your car may be right for you. If you have other assets like boats, collectibles, recreational vehicles, etc., that you are considering passing down to your heirs, sit down with them and do some estate planning to determine if they would rather have the house or the other assets.
If you have stocks, bonds, or real estate investments, it is a good idea to sit down with a financial planner to determine if selling those off to access cash could be a better financial choice than paying the fees associated with a reverse mortgage.
What makes someone a good candidate for a reverse mortgage?
A reverse mortgage is best for people who have lots of equity in their home, who have limited income in retirement, and who either don’t want to leave their house to their heirs or have heirs who can pay off the reverse mortgage when the homeowner passes.
Who should not get a reverse mortgage?
Anyone who wants to give their home to their heirs or to charity free and clear should not get a reverse mortgage. Reverse mortgages have relatively high fees, so people who are able to get home equity loans, home equity lines of credit (HELOCs), or refinances with better terms should also look for alternatives to a reverse mortgage.
How do you repay a reverse mortgage?
You only have to repay a reverse mortgage if you sell the home, pass away, or reside outside the home for more than a year. Generally, your heirs will repay the reverse mortgage with their own funds or through some sort of refinance on the property.
Mortgage lending discrimination is illegal. If you think that you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).
The Bottom Line
Reverse mortgages may be a good option for people who are house rich and cash poor, with lots of home equity but not enough income for retirement. However, there are other options that allow you to tap into the equity that you have built up in your home.
Before making any decisions, it’s a good idea to research your options, shop around for the best rates (where applicable), and consult with a qualified tax specialist or attorney.