Reverse Mortgage vs. Cash Out Refinance
By: Review Counsel Staff
October 21, 2024 • 6 minute read
If you own a home and are in need of cash, you have several options for obtaining the money you need by tapping into the equity you have in your home. Two common ways are through a reverse mortgage and a cash-out refinance.
Let’s look at the differences, so you can know which one may be right for you.
Reverse Mortgage: What is it and How Does it Work?
The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM). The HECM reverse mortgage is a loan just like a traditional mortgage, but instead of paying it back with regular monthly payments, it is paid back when the homeowner decides to sell, the home is no longer the primary residence of the homeowner, or the homeowner becomes deceased.
As the name implies, a HECM reverse mortgage allows homeowners to convert some of their equity into cash. The first thing that happens when a homeowner takes out a reverse mortgage is that it pays off the current mortgage, if there still is one. This also means that it eliminates monthly mortgage payments.
With the remaining cash, homeowners have the option of receiving the funds as a lump sum, monthly payments, a line of credit or a combination of the three.
However, a reverse mortgage is not available to every homeowner.
In order to qualify, homeowners must meet very specific requirements, including the following:
- You or your spouse must be at least 62 years old
- The home must be your primary residence
- You typically need a minimum of 50 percent equity built up in your home
- The home needs to be in good condition
- You need to be able to continue to pay for maintaining the home, pay property taxes, and pay for homeowners’ insurance
Why Choose a Reverse Mortgage
A reverse mortgage may be a good choice for older homeowners in a variety of scenarios. While everyone’s situation is unique, here are some scenarios that may make a reverse mortgage an appealing option.
- Retire in place. A reverse mortgage may be a good option for homeowners who want to stay in their homes, but they also want to take advantage of the equity they’ve accumulated in their home.
- Supplement your income. If you are trying to make ends meet on a fixed income, and you are finding it’s not enough, then a reverse mortgage is one way to solve that problem by option to receive your funds in the form of monthly payments.
- Eliminate monthly mortgage payments. One thing that makes a reverse mortgage unique compared to a cash-out refi is the ability to eliminate monthly mortgage payments. This is another way to free up some cash if you are living on a fixed income.
- Renovate your home. If you are wanting to do major renovations or upgrades to your home, a reverse mortgage is one way to obtain the cash to fund those upgrades without having to take out a loan that will require monthly payments to pay it back.
- Save for a rainy day. Some homeowners opt to receive the funds as a line of credit to use the money they receive from a reverse mortgage to cover unexpected expenses.
The funds from a reverse mortgage could also be used to pay off consumer debt, travel, purchase a different home, and many other uses. There are no limitations on how the money from a reverse mortgage can be used.
Read our complete reverse mortgage guide to learn more.
Cash-Out Refinance: What is it and How Does it Work?
A cash-out refinance is a mortgage refinance with a twist. Homeowners typically decide to refinance their home because they want a better interest rate or better terms. But in the case of a cash-out refinance, they are also able to take out some of the home’s equity in cash in a lump sum.
Because the homeowners are taking out additional money on top of their current loan balance, the new refinanced mortgage is larger than the previous home loan.
Like a reverse mortgage, the homeowners are able to use the cash for any purpose or need they have including home upgrades, paying off debt, or paying for college.
Because a cash-out refinance is a new mortgage, it also includes closing costs and appraisal fees. However, these tend to be less than with a new home purchase.
A cash-out refinance also comes with some requirements. These may vary depending on the lender you work with, but this is what you can expect in order to qualify for a cash-out refi:
- Have more than 20% equity in your home
- Verify your income and employment
- A minimum credit score of 620
- A home appraisal to assess the market value
- Debt-to-income ratio that is 43% or less
- Loan-to-value ratio that is 80% or less
There is no age requirement for obtaining cash-out refinancing.
Why Choose a Cash Out Refinance
A cash-out refinance typically only makes sense if the homeowners are able to obtain a lower interest rate because borrowers will end up paying more in interest since the mortgage balance is increasing.
“Cash-out refinancing is beneficial if you can reduce the interest rate on your primary mortgage and make good use of the funds you take out,” says Greg McBride, the chief financial analyst for Bankrate.
In other words, you want to make sure it’s worth it. If you obtain a cash out mortgage refinance with a good interest rate, and you plan to use the money on a major home renovation, this would be beneficial because you are getting a lower interest rate and investing the money back into the home, which should help to increase the value of the home.
Which Should You Choose?
Deciding between a reverse mortgage and a cash-out refinance to access your equity first comes down to which one you qualify for.
If you qualify for both, the next question is to decide which one will meet your needs. If you are okay continuing to take on a monthly mortgage payment, then cash-out refinancing may be the way to go.
If you would like to access your equity, eliminate monthly mortgage payments, and want more options for how you can access the funds, then a reverse mortgage may be the solution you are looking for.
If you are interested in pursuing a cash-out refinance, check out our list of recommended mortgage lenders.
If you think a reverse mortgage makes sense for you, check out our list of recommended reverse mortgage lenders.
| Key Features | Reverse Mortgage | Refinance |
|---|---|---|
| Age Requirement | Must be at least 62 years old | No age requirement |
| Equity Requirement | At least 50% equity | At least 20% equity |
| Residency Requirement | For primary residence only | For primary or secondary residence |
| Credit & Income Requirement | No credit or income requirement | Minimum 620 credit score and steady income |
| Funds Disbursement | Lump sum, monthly payments, line or credit or combination of the three | Lump sum |
| Repayment | Paid back when the home is sold, it is no longer the primary residence, or the homeowner passes away | Monthly payments |
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.
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