Here are the pros and cons of three common ways to tap your home equity: a reverse-mortgage loan, a home-equity line of credit, and a cash-out conventional mortgage refinancing
Retirees may need an extra infusion of cash for a variety of reasons.
They could have an unexpected hospital visit, want to refurbish their home, pay down credit-card debt, be ready for a vacation or have some other expense.
They often tap the equity they have in their home to get additional funds.
Three common ways to do this include taking out a reverse-mortgage loan, obtaining a home equity line of credit or applying for cash-out conventional mortgage refinancing.
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Bankrate asked financial experts about the pros and cons of each method. When you compare your situation to the possibilities and requirements, you’ll determine which option works the best for you.
Request a reverse mortgage loan
Different types of reverse- mortgage loans exist, but to make this simple we are talking about the most popular — a home-equity conversion mortgage, or HECM. The Federal Housing Authority’s reverse- mortgage loan program makes HECMs available through lenders.
“It’s a way for people 62 years of age and older to access some of the equity they’ve earned in their home without selling the house,” says Laura Kiel, of Kiel Mortgage in Renton. “You can receive your funds as a lump sum at closing, paid to you in equal amounts each month, in a line of credit available to you or a combination of all three.”
If you choose a home- equity line of credit, that money increases over time, she says.
Out-of-pocket fees — including closing costs, an appraisal and other charges — vary by mortgage company, but the average is around $700, Kiel says. There’s also mandatory counseling, which requires a fee, to make sure you completely understand the loan and its terms. That fee usually runs $100 to $200.
FHA insurance is also factored in to the reverse- mortgage loan amount. When you get a reverse- mortgage loan, you no longer have monthly mortgage payments, but you still must pay the taxes, insurance and maintenance expenses on your home.
If you sell your home, the loan is repaid with the proceeds.
Apply for a home equity line of credit
A home-equity line of credit, or HELOC, generally comes from a bank, says Barry Sacks, a practicing tax and pension lawyer in San Francisco.
Unlike a HECM, there is no restriction on the age of the borrower.
“The amount you can borrow as a line of credit depends on the value of your home, your income, credit rating and the bank’s policy,” Sacks says. “The interest rate for this loan can be fixed or variable, depending on the lender.”
Although your HELOC won’t increase automatically, Sacks says in some cases the borrower can negotiate an increase in the amount available.
But you’ll need to quit dipping into the credit line and start paying it back within seven to 10 years. You must repay both the principal and the interest.
The lending bank can cancel a HELOC at any time, and banks did this in a big way during the Great Recession. That can be a significant risk, especially for a retiree who may need the money at just the point in time when the cancellation occurs, Sacks says.
Acquire cash when you refinance
When you apply for a conventional cash-out refinancing, you replace your first mortgage plus get a lump sum of money to help you out with your financial needs. Your new loan is for a larger amount than your existing home loan and ideally at a lower interest rate.
To qualify for this option, a retiree must meet certain credit and income requirements, says Steven Sass, a research economist for the Center for Retirement Research at Boston University in Chestnut Hill, Mass. These requirements are much stricter than those for a reverse-mortgage loan, he says.
You also pay closing costs, which can run into the thousands of dollars.
“What a borrower can get is largely determined by the value of the house (as collateral), the borrower’s ability to repay the debt and the lender’s maximum loan-to-value (ratio) on a refi,” Sass says.
Loan-to-value ratio is the current mortgage amount divided by the appraised value to a maximum amount of about 75 percent to 85 percent.