Reverse mortgage funding may sound like a good idea but these mortgage alternatives will get you the money you need without the high cost and risks
Having mortgage alternatives is important because you must always want to have a safety net in case something goes wrong with your plan. There are some uncommon methods that you can use to be able to save money for other things and at the same time, still own a home and live mortgage-free.
When we talk about mortgage alternatives, we are talking about ways of getting out of the regular monthly payments characteristic of mortgages by finding better options than what an everyday lender can offer. It's not really an alternative, but more like an alternate option for those who think they know better and are capable of doing things on their own without having any help from outside sources. One advantage is the loan amount will be smaller which means less interest should paid in the long run. Being resourceful will get you very far in this life, especially when it comes to saving money for something important.
Two questions are always top-of-mind when retirees email me about their finances, how much do different living options cost and how to pay for expenses. They want to continue living in their own home but are afraid the mortgage payment and upkeep might be too much.
That’s when they see a familiar face on TV, talking about a great way to stay in their home and not make payments the rest of their lives. The solution is called a reverse mortgage and lenders love to parade trustworthy TV stars out to convince you (I’m looking at you Mr. Trebek).
There’s a lot to like about the idea. You get to stay in your home, never make a payment again and maybe even get a little cash out of it.
What’s not to like?
There’s also a lot not to like about reverse mortgages and these are always in the small print of the contract, small enough that even someone with perfect vision would have a hard time reading.
Let’s look at what a reverse mortgage does and some of the dangers in this type of loan before looking at some reverse mortgage alternatives that will get you the money you need without those risks.
What is a Reverse Mortgage?
A reverse mortgage is a loan. Don’t let anyone tell you differently. It’s set up so you don’t make payments but it’s still a loan with a cost.
Reverse mortgages were formally signed into law as the Home Equity Conversion Mortgage (HECM) program in the 80s. They are only available to homeowners 62 years and older in single-family homes up to four units or manufactured homes if they meet FHA standards.
The payment plan on a reverse mortgage is what makes it different from other home loans…because there is no payment plan. The lender pays off any existing mortgage and then just sits on the loan. When the homeowners pass away or move, the full amount of the loan comes due.
It seems pretty simple. Stay in your home with no payments. When you pass then your family refinances or sells the home to pay off the reverse mortgage.
Just a minute though, it’s not so simple.
How Does a Reverse Mortgage Work?
Why would a lender make this kind of a deal? If they’re not getting payments for years, maybe decades then what’s in it for them?
The benefit to a reverse mortgage lender is in the interest it eventually collects and a mountain of fees it gets at the start.
When you apply for a reverse mortgage, the lender will send an appraiser to your home and will check all existing mortgages. While you can usually get a traditional refinance on your home if the house is worth around 10% more than the mortgage, your equity value, you won’t be approved for a reverse mortgage unless your home is worth much more than the debt.
In fact, many reverse mortgage lenders require that your home be worth double what you owe on it.
This is so the lender knows that there will be a lot of value in the home when they go to sell it, even if they have to wait a while. You see, that interest that you’d be paying on a normal mortgage is still adding up on a reverse mortgage even though you’re not making payments.
In a normal mortgage, you pay less interest each year because you pay down some of the debt as well. In a reverse mortgage, you end up owing more each year because interest is piling up on the original debt PLUS all the interest that hasn’t been paid.
Just the interest on a $50,000 reverse mortgage can add up to over $110,000 over 20 years!
Dangers of a Reverse Mortgage
That growing mountain of interest is only part of the problem with reverse mortgages. After all, you’re not really worried about the interest because you’re not making payments on the loan.
The real kicker to a reverse mortgage is in the upfront fees.
A standard refinance mortgage will cost around 2.5% in fees to the lender and mortgage broker. A reverse mortgage is almost always at least twice that much and more.
For example, a typical refinance will cost around $5,000 in fees including appraisal, title, escrow and taxes. Compare that with the $11,000 paid by my aunt when she took out a reverse mortgage, more than twice the cost of a regular mortgage.
Besides the fees, the interest rate on a reverse mortgage is usually much higher than another type of mortgage. The current average rate on a 30-year fixed refinance is 4.74% while the average rate on a reverse mortgage is 5.75% plus a 1.25% mortgage insurance charge.
The higher rate means a reverse mortgage would cost an additional $51,933 over a traditional mortgage of $100,000 over 30 years.
This might still not sound like too much of a risk on reverse mortgages. Who cares about the cost if you’re not making payments? The problem is that when you pass or decide to sell the house, all that money comes due immediately.
What if you need to move to an assisted living community? What if something happens and you can’t afford the upkeep on the house? It might seem like a reverse mortgage gives you financial flexibility by saving those payments but it actually locks you into a deal you might not want.
Best Reverse Mortgage Alternatives
There are alternatives to reverse mortgage funding that will save you money and cause a lot less stress. These range from the typical to some strategies you might not have thought of but all will leave you better off compared to a Home Equity Conversion Mortgage.
Home Equity Line of Credit (HELOC) loans are typically used for home improvement loans but can be used for just this situation. You apply for a loan on the amount of equity you have in the home, the value of the home over what you owe on the mortgage, and get cash for that amount.
This means you’ll have two loans on the home, the mortgage and the HELOC, but you use the cash you get from the home equity loan to make your monthly payments on the mortgage and the HELOC.
Rates on HELOC loans are just a little higher than traditional mortgages and well below what you’ll pay on a reverse mortgage. Fees for a HELOC are lower than a refinance so you’ll save thousands compared to a reverse mortgage.
Refinance your original mortgage – You might not have much of a choice if you haven’t paid off most of your mortgage. Reverse mortgages are only available to homeowners that owe less than 60% of their home’s value.
A great alternative might be just to refinance your home. Since you’re refinancing for the same amount you owe, not for the original amount on your loan, you’ll be able to lower your monthly payments drastically.
For example, if you bought your home 16 years ago for $150,000 on a 30-year mortgage at a 4% rate then your payments would be $716 a month. After 16 years, you would still owe $91,892 on the mortgage and have those same monthly payments.
But if you refinanced that $110,000 on a new 30-year loan at 4%, your payments would decrease to $438 a month. That’s almost $300 a month you can put to other expenses.
Granted, this puts you back in a 30-year loan but understand that a reverse mortgage is no different. In fact, a reverse mortgage is an infinite-term loan that never ends.
Personal Loans may be another good alternative to a reverse mortgage if you just need some money to pay expenses. The rate on a personal loan is higher but the loan isn’t tied to your home so you won’t risk losing it like with a traditional mortgage.
You can also use a personal loan to pay off your original mortgage so you don’t have any payments left. I’ve used personal loans to pay off credit card debt and for a home improvement project, both times saving on interest I would have owed otherwise.
Where you get a personal loan depends on your credit score. Some personal loan sites will only approve good credit borrowers while others specialize in bad credit loans.
- PersonalLoans is the site I’ve used the most for debt consolidation and they generally approve just about anyone.
- SoFI has stricter lending requirements but usually lower rates and they offer a home refinance loan beside the personal loan.
- Payoff specializes in loans to pay off credit card debt but you can use the money for any reason
It doesn’t hurt your credit score to apply for a loan on more than one site so I usually recommend applying on at least two. That helps to make sure you get the lowest rate possible and the best deal you can.
Sell your Home to Your Children with the agreement that you live there with no payments. There’s a trust factor here but I’ve never heard of children forcing their parents out of their home with this kind of a deal.
Your kids take out a regular mortgage for the amount you owe plus fees and make payments every month. That means you get free of the payments and your kids get all the equity in the home. Rates and fees will be much lower and your kids won’t be forced to sell when you pass.
This is essentially the same thing as a reverse mortgage but without the dangers in higher rates and fees. Your kids are getting those tens of thousands you would otherwise lose to the reverse mortgage lender.
I know the idea is to retire and stay in your home but downsizing might also be an option to consider. It means selling your home but still allows you to live independently and with a much lower monthly payment.
A reverse mortgage sounds like a great deal until you look at the fine print and understand how they actually work. These types of loans charge almost twice the fees and interest as others and you won’t realize it until you try to move or sell the house. The only ones that win in a reverse mortgage are the lenders and everyone collecting the fees. Consider these reverse mortgage alternatives as a low-cost way to get the money you need and stay in your home.
Read the Entire Mortgage Series
- 4 Best Ways to Repay Your Mortgage Faster
- How a Portfolio Loan Can Help You Get a Mortgage on Bad Credit
- The Financially-Dumb Answer to Pay Off the Mortgage or Invest
- 5 Reverse Mortgage Alternatives to Get the Money You Need
- Pay Off My Mortgage Early? Pfft…Not in This Economy!
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.