We all know that the process of buying a home is expensive and time-consuming. For many people, this means taking out a mortgage to finance their purchase. The decision to purchase a home is one of the most significant decisions you can make.
When deciding between a mortgage and a reverse mortgage, you should consider different factors before making this big step. To understand the difference between these two options, you should understand what each option entails.
In this article, we’ll discuss;
- The differences between mortgages and reverse mortgages.
- Their benefits and drawbacks.
- And other important factors that will help determine which option is best suited for you.
A mortgage is a loan against real property. It’s one of the most common types of financing for home purchases.
When you take out a traditional mortgage, you borrow money (typically from a financial institution) to purchase your home. Once you pay off the loan, the ownership of the home transfers to you.
The biggest advantage of taking out a mortgage is that it grants homeownership of the property over time. Rather than paying for an entire house in cash upfront, mortgages allow you to pay off the cost of the house over time.
A reverse mortgage is a type of loan that does not require any repayment until the borrower dies, sells the home, or permanently leaves. This option is typically available to older homeowners who are at least 62 years old or older.
They receive a lump sum of cash from a lender or an ongoing line of credit that provides regular payments/withdrawals. The homeowner is not required to repay this loan as long as they continue living in and maintaining their home.
The biggest advantage of taking out a reverse mortgage is that it gives homeowners the freedom to use the money in any way they see fit. They don’t need to make payments on the loan until specific requirements are met, such as death, moving out of the home, or selling their property.
How does a mortgage work?
Before applying for a mortgage, you should assess your current financial situation. You are required to prove that you can afford monthly payments on both the house and the loan taken out to finance it.
Therefore, deciding whether or not you will be able to repay your loan based on your income is one of the first things you’ll need to consider.
Most mortgages are 15 years or 30 years in length. When you take out a 15-year loan, the monthly payments will be higher than if you take out a 30-year loan.
However, suppose you opt for a 30-year mortgage. In that case, you will pay significantly less per month on your mortgage payment (since your repayment period is twice as long as that of a 15-year mortgage).
How does a reverse mortgage work?
Reverse mortgages are loans that you don’t have to pay back until you die, sell your home, or move out. You can receive an upfront payment, a lump sum paid when the property is sold, or a line of credit for regular withdrawals from the home’s equity. The money will be deposited in a checking account and will accrue interest.
When you opt for a reverse mortgage, your property becomes an asset that can be passed on to children or heirs. You do not have to make monthly payments. Still, the amount of equity you withdraw is based on the age of the youngest borrower (the older you are, the more equity you can get).
Moreover, if you have a mortgage on the property, the lender will pay it off when you take out a reverse mortgage.
Benefits: Mortgage vs. Reverse Mortgage
- Financing a house purchase
- Build equity in your home
- Can live in the house for as long as you repay the loan
- Can get a fixed-rate or variable-rate mortgage
Reverse Mortgage benefits:
- No more monthly payments on your mortgage loan
- Money from a reverse can be non-taxable income
- Equity in your home is protected from creditors during bankruptcy
- Can get an upfront lump sum or a line of credit
Whichever option you choose, make sure to understand all the terms and conditions before signing the agreement. It may be worth it to sit down with a reverse mortgage specialist who can explain all your options to help you choose the best solution based on your circumstances.
Drawbacks: Mortgages vs. Reverse Mortgages
- Must have enough equity in your home to be approved for the loan
- Monthly payments over 15 or 30 years
- Can lose the house if you cannot make payments
- Risk of foreclosure when payments are not made on time. If the mortgage is not paid off, you may lose your home to the lender.
Reverse Mortgage drawbacks:
- No payments are required initially, but payments may be due upon moving out of the house or at the time of your death.
- Risk of foreclosure if the property is not maintained well and there is no equity in the home (if at any point borrower owes more to the lender than the home is worth, they can lose their house to foreclosure)
- There are risks associated with the possibility that your heirs may not want to assume ownership of the property after your death. (if no one wants to take ownership, it will be sold, and your heirs or children will receive none of the proceeds from the sale).
Eligibility Criteria: Mortgages vs. Reverse Mortgages
Eligibility requirements depend on the lender you are working with. But here are some general guidelines:
- Minimum age of 18
- U.S citizenship or permanent residency
- Your debt-to-income ratio must be high enough to get approved for a mortgage
- FICO score should be good enough to get a loan
Reverse Mortgage eligibility:
- The federal government-backed FHA loans require you to be at least 62 years old, and the property must be your primary residence.
- Your total household income cannot exceed the maximum limits set by the Federal HECM guidelines (these limits are based on the area where you live)
- You as a borrower have to pay an up-front insurance premium, origination fee, loan servicing fees, ongoing mortgage insurance premiums, and interest.
Mortgage vs. Reverse Mortgage: Which is Right for You?
As you can see, both mortgage and reverse mortgage have their advantages and disadvantages. It really depends on your circumstances to determine which one is most suitable for you.
For example, a reverse mortgage may be a good option if you do not have anyone to leave the property to and would like a steady source of income from your equity. However, you should consider that if you take out a line of credit, you will accrue interest and owe more money than you initially received.
On the other hand, a traditional mortgage is a good option if you have heirs who will assume ownership of your property. But your heirs or children should be willing and able to afford the monthly interest payments.
If your children do not want the home upon your death, it can be sold, and they may receive up to the total amount of the sale minus foreclosure fees.
If you are currently contemplating a mortgage or reverse mortgage, get in touch with a qualified specialist to explain all your options. A specialist can help you identify which loan is best in your situation.
In short, a traditional mortgage can be a good option if you have heirs who will assume ownership of your property and can afford the interest payments.
However, you should consider that your home can be sold if they do not want to assume ownership of the house upon your death. Your heirs might receive up to the full amount minus foreclosure fees.
On the other hand, a reverse mortgage may be a good option if you do not have anyone to leave the home to and would like a steady source of income from your equity.
You should also consider that if you take out a line of credit, you will accrue interest and owe more money than you initially received.
It is important to consider your unique situation to determine which loan will be best for you with either choice. The best idea would be to hire an experienced specialist to help you decide the best option based on your unique situation.