Using the equity in your residence is a method many people use to raise cash. There are several methods that a homeowner may use to tap into this income vein, but some may be better suited than others.
One popular option—that 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 you may want to consider are traditional cash-out mortgage refis, second mortgages, or sales to family members, among others.
The Reverse Mortgage
If you’re 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 or 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 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: If you refinance instead of getting a reverse mortgage, your home and the equity it builds remains an asset for you and your heirs.
2. Take Out a Home-Equity Loan
Essentially a second mortgage, or home-equity loan, lets you borrow money by leveraging the equity you have in your home. It works the same way your primary mortgage does: You receive the loan as a single lump-sum payment, and you cannot draw any additional funds from the house.
For tax years up to and including 2017, interest on a home-equity loan for amounts up to $100,000 is generally deductible regardless of how you used the loan, be it for credit card debt or student loans. And if you use the loan for what are called qualified purposes—which are to “buy, build or substantially improve the residence that secures the loan”—you could take tax deductions on up to $1 million (including any first-mortgage debt you have).
However, the new Tax Cuts and Jobs Act has narrowed the eligibility for a home-equity loan deduction. For tax years 2018 through at least 2025, you will not be able to deduct home-equity loan interest unless the 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.
These are generally fixed-rate loans, which provide security against rising interest rates. Because of that, the interest rate is typically higher than for a home equity line of credit. 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.
Take Out a Home Equity Line of Credit
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 you actually withdraw. HELOCs are adjustable loans, meaning 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.
Sell Your Home or Downsize
The options above keep you in your existing home. If you’re willing and able to move, however, selling your home gives you access to the equity you have built.
This option may be especially appealing if your residence is larger than you currently need, 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.
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 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 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).
Although it’s not free to set up this type of arrangement, 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.
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. There are other options, however, that allow you to tap into the equity 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.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau and/or with the U.S. Department of Housing and Urban Development (HUD).