May 17, 2023
Life often doesn’t work out the way we planned.
Factors out of your control can leave you with a nest egg that is a lot less egg-y than you like — maybe there was a career change, a pandemic, or record-setting inflation.
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But if you own a chunk of equity in your home, there are concrete ways you can use it to pad your bank account.
Let’s take a look at two of the most common options presented to people who need to turn their home equity into much-needed cash.
More: Best reverse mortgage lenders of 2023
Is a reverse mortgage the same as a refinance?
No, a reverse mortgage isn't the same as refinancing, but they are similar products.
While there are different types of reverse mortgages, home equity conversion mortgages (HECM) — which are backed by the Federal Housing Administration (FHA) — are the most common type of reverse mortgages, according to the Consumer Financial Protection Bureau.
They are only available for homeowners who are 62 years old or older.
Just like a “traditional” mortgage, a HECM helps you borrow money, but uses your home as collateral.
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Although amounts vary depending on the lender you choose, lenders typically want borrowers who own at least 50% of their home. You also can’t owe, or be delinquent on any federal debt (like student loans).
A reverse mortgage has key differences from a traditional mortgage.
With a traditional mortgage you can make a down payment, and then pay off the rest of the loan with monthly payments.
With a reverse mortgage, you get the home equity cashed out and receive it in (typically monthly) cash installments. Interest keeps accruing, but you don’t have to repay it until you move, or you die, whichever comes first.
Interest and other fees will continue to accrue, and homeowners are still required to pay their property taxes.
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Other requirements include keeping that property as your primary residence, and keeping it in good repair.
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How does refinancing work?
Refinancing a mortgage (or refi) is about getting a new loan to replace your current mortgage. This is an option for homeowners who want to lower their interest rates and reduce their payments.
With a refinance, you use the new mortgage to pay off the balance of the old, and you don’t need to be any particular age in order to do it.
The key difference between a HECM and a refi is that when you refinance your home, you don’t see any money; the lender takes care of the transactions behind the scenes.
Once the mortgage has transferred over, you begin to make monthly payments again at your new rates.
Basically, to you as the borrower, a refinanced mortgage will feel much the same as a traditional one. However, a refinance should lead to you having lower monthly fees. Your closing costs may also be less.
Reverse mortgage pros and cons
| Pros | Cons |
|---|---|
| You pay off your existing loan | Loan balance keeps increasing as time passes |
| You can stay in your home | Potential foreclosure, if you miss one too many payments |
| It can bridge those years between 62 and retirement | If home equity is a major part of your legacy, your heirs could inherit less |
| No tax liability | It could impact your retirement benefits |
| You have protection in case your loan amount exceeds your home’s value | They are complicated |
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Refinance pros and cons
| Pros | Cons |
|---|---|
| Lower monthly payments and interest rates | Pay more in total interest |
| Reduces your loan term | Must pay closing costs |
| With a cash-out refi, you get money for whatever you need and typically pay less interest | Less equity |
| Eliminates private mortgage insurance (PMI) | Slight dip in your credit score |
| Cashes out your equity | Could fall into more unintentional debt |
When does a reverse mortgage make sense?
A reverse mortgage makes sense if you are older than 62, own your own home, have repaid a significant portion of your mortgage on that home and don’t have a lot of savings. It can help supplement your Social Security payments.
When does a refinance make sense?
According to the consumer credit reporting agency Equifax, it makes sense to refinance your mortgage if you can lower your interest rate by 0.5% to 1%.
It also makes sense to refinance your mortgage if your personal finances have improved since you signed your current mortgage, or if a new mortgage would save you having to pay for private mortgage insurance.
FAQ
Can I refinance for home improvements?
Yes, you can, if you meet certain requirements.
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Although the requirements change from lender to lender, typically lenders look for you owning 20% equity in your home, (otherwise known as loan-to-value ratio).
According to the government-sponsored mortgage company Freddie Mac, you can refinance your current mortgage to one designed specifically for helping you complete home renovations, or you can get a cash-out refinance.
Freddie Mac offers two home renovation refinance options. CHOICEReno is for a variety of renovation needs, and CHOICEReno eXPress is for help with the smaller jobs such as repainting your kitchen.
The other federally-sponsored mortgage company, Fannie Mae, also offers refinance options, like their HomeStyle Renovation loans.
You can bundle those with different offers if you want to do renovations on a specific aspect of your home, like applying for HomeStyle Energy if you want to improve your energy efficiency.
Will I be able to build equity if I refinance my house?
Refinancing your house doesn’t affect your equity necessarily — what does is the fluctuations in the housing market, property values, closing costs and lenders’ fees.
Can you refinance a reverse mortgage?
Yes, you can refinance a reverse mortgage if you need to.
Typically, you’d refinance a new reverse mortgage if you found that the rates had significantly dropped since you first signed your contract. Since 2004, the U.S. Department of Housing and Urban Development, (HUD), has had legislation in place to protect the borrower from paying more than they should to renegotiate their terms.
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Bronwyn is currently part of the email content team for Moneywise. Before starting here, they freelanced for several years, focusing on B2B content and technical copy. Pre-pandemic, you could find them planning their next trip, but lately, if they're not at work, you can find them hanging out with their cat and dog.
