Reverse Mortgage vs. Mortgage Refinance: Which One is Right for You?
By: Kelly South
February 21, 2023 • 8 minute read
Reverse Mortgage vs. Mortgage Refinance: Which One is Right for You?
One of the best perks of owning a home is that it’s not just the place where you spend time with your family and lay your head every night, but it’s also an investment — a way to grow your wealth.
This happens as you build up equity in the home. Equity goes up as you pay down the mortgage and the market value of the home goes up.
There are several ways to access that equity by borrowing against it. Two options are mortgage refinancing and a home equity conversion mortgage (HECM), also known as a reverse mortgage.
While both options will allow you to take advantage of that growing equity, they work very differently and serve different needs.
Let’s find out which one is right for you.
What is a Reverse Mortgage and How Does it Work?
A reverse mortgage is a loan that allows homeowners to tap into their home’s equity. The reverse mortgage eliminates the current mortgage, which also means eliminating monthly mortgage payments. However, homeowners are still responsible for paying for taxes, insurance, and any maintenance costs.
Homeowners who take out a reverse mortgage will have the option of receiving their funds as a lump sum, monthly payments, a line of credit, or a combination of the three.
However, a reverse mortgage comes with specific requirements:
- At least one homeowner must be 62 years of age or older.
- The home must be the primary residence of the homeowner. A reverse mortgage cannot be used on a secondary home or investment property.
- You typically need about 50 percent equity built up in the home.
- The home needs to be maintained, and homeowners must continue to pay property taxes and homeowner’s insurance.
Reverse mortgages do include interest, but interest payments are deferred until the mortgage is repaid.
The reverse mortgage is not paid back in monthly payments, like a traditional mortgage. It is paid back when the home is sold, it is no longer the primary residence of the borrowers, or the borrowers pass.
Typically, the proceeds from the sale of the home will pay off the reverse mortgage, and the homeowners or heirs will be able to keep any money beyond that.
There are several ways borrowers can use the funds from a reverse mortgage including:
- Supplementing monthly income
- Make home repairs
- Pay for home renovations
- Pay off existing consumer debt
- Pay medical bills
- Travel
What Problems Does a Reverse Mortgage Help Solve?
A reverse mortgage may be a good option for retired homeowners looking for a solution to a variety of problems. Here are just a handful of scenarios that a reverse mortgage may help.
Supplementing a Fixed Income
First, a reverse mortgage may help homeowners who are living on a fixed income and are looking for an additional way to supplement their income. A reverse mortgage helps by first paying off the current mortgage, which will help free up some cash. Next, borrowers may opt to receive their funds as monthly payments, which will help increase how much liquid cash they are able to bring in each month.
Pay Off Consumer Debt
If homeowners find themselves heading into retirement with a large amount of consumer debt, a reverse mortgage can be used to pay off consumer debt including credit card debt, medical bills, a car loan, and personal loans. Homeowners looking to pay off debt may benefit from receiving at least part of their funds as a lump sum.
Pay for Large Project
If your home hasn’t been updated in a while, it may be time to complete some home renovations, which typically come with pretty hefty price tags. A reverse mortgage can be used to help pay for these upgrades. Receiving at least part of your funds as a lump sum would be a good option in this situation.
Save for a Rainy Day
Homeownership and retirement can come with unexpected expenses. This is where choosing to receive reverse mortgage funds as a line of credit would be a good choice. If you don’t feel like you have the resources to cover large, unexpected expenses, this may give you the peace of mind you need.
Purchase a New Home
While a reverse mortgage is a great option for those who want to retire in place, it can also be used to purchase a new home. This is known as HECM for purchase or reverse mortgage for purchase.
Those in retirement may decide they want to move to be closer to family or downgrade to a smaller home. A reverse mortgage for purchase will pay off your current mortgage and then the remaining can be put toward a different home. It allows you to purchase a new home without taking on monthly mortgage payments.
Get a New Reverse Mortgage
If you already have a HECM loan there are several reasons why you may want to refinance your reverse mortgage including: obtaining more money if your home’s value has increased, taking advantage of the increase in the FHA lending limit, or getting a new interest rate, to name a few.
What is Mortgage Refinancing and How Does it Work?
Refinancing a mortgage means replacing the current mortgage with a new mortgage, but typically with a new balance and new terms.
As part of the refinancing process, the original mortgage gets paid off, so you will still only have one mortgage and continue to only have one monthly payment.
It can take between 30 to 45 days to refinance your home. The process is similar to buying a home, but it is typically less complicated.
While the specific process may change from lender to lender. This is the overall process you can expect:
- Submit an application
- Get approved and lock in your interest rate
- Underwriting processes the loan
- Home appraisal is performed to confirm the value of the home
- The loan is closed and finalized
There are costs involved in refinancing a home, but they are typically less than purchasing a new home. Homeowners can expect to pay 2% to 6% of the total loan value in closing costs. Other fees may include an application fee, appraisal fee, attorney fees (where applicable), and title search fees (if required by your lender).
What Problem Does Mortgage Refinancing Solve?
Mortgage refinancing may be used to solve a variety of problems. There are several reasons why someone might choose to refinance a mortgage.
Better Rate
One common reason someone might choose to refinance a mortgage is to get a better interest rate. This may happen if the original loan was taken out when interest rates were high, and they have since dropped. A mortgage refinance in this situation typically means a lower monthly payment.
Change Loan Terms
Another common reason homeowners choose to refinance is because they want to change the loan terms. If someone started out with a 30-year term, they may want to switch to a 15-year term, which will allow them to save money on interest. Or they may want to switch from a shorter term to a longer term to lower their monthly payments.
Change Loan Type
If homeowners started out with an adjustable-rate mortgage (ARM) when they first took out their mortgage, they may want to change to a fixed-rate mortgage when the interest rates start to go up. Or if they started out with an FHA loan, which requires private mortgage insurance (PMI), they may want to change to a conventional loan that doesn’t require PMI.
Cash Out Refinance
Homeowners may want to refinance their home if there has been a significant increase in the market value, and they want to access their equity. This is typically done if there is a major home improvement project they want to complete or to consolidate debt. In this case, they would take out a loan that is more than what they owe on the loan and take the difference as cash.
The advantage of a cash-out refinance is that the interest rate on mortgages is much lower compared to other types of loans. However, there may be tax implications they will want to consider.
Remove a Person
There are cases in which it may make sense to remove someone from a mortgage, such as a divorce, in which refinancing a mortgage needs to be done.
Add a Person
Someone may choose to refinance a mortgage because they want to add someone to the mortgage. This may happen because the person gets married, or they want to add a partner to an investment property.
Which one is Right for You?
Whether you choose a reverse mortgage or to refinance your current mortgage comes down to two questions: Do you qualify and what problem do you need to solve?
First, if you are thinking of pursuing a reverse mortgage, you need to make sure you qualify. Reverse mortgages come with very specific requirements, and if you don’t meet those requirements, then this isn’t a good option for you at this time.
If you meet the requirements of both a reverse mortgage and mortgage refinancing, the next question to ask is: “What problem do you need to solve?”
If what you need is to increase your income, pay for upcoming projects, or you simply want a rainy-day fund, then a reverse mortgage may be the way to go.
If you don’t meet the requirements of a reverse mortgage, you may still be able to tap into your equity in the form of cash-out refinancing. Or maybe you simply want better terms or a better interest rate.
If you are ready to pursue a reverse mortgage or refinancing, get started by checking out our list of recommended reverse mortgage lenders or our list of recommended mortgage lenders to assist with your refinancing.
| 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 | No funds disbursed (unless it is a cash-out refi) |
| 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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