As the retirement-income gap widens, more and more Americans are looking for ways to cover everyday costs. If you’re a retired homeowner and need to boost your income, you may want to consider two ways your home can help you meet your financial needs: a reverse mortgage and a home equity line of credit (HELOC). Be sure to understand what they are so you’re comfortable with their drawbacks if you move forward with either option.
What is a reverse mortgage?
If you’re 62 or older, own your home, use it as your primary residence, or have a substantial amount of equity, you’re probably eligible for a reverse mortgage.1
Also known as a home equity conversion mortgage, a reverse mortgage lets you trade some of your home equity for cash. Unlike a traditional mortgage, however, you don’t have to make payments as long as you stay in the house. Your interest is deferred until you move out, too.2
Reverse mortgages have been subject to stricter lending regulations and expanded consumer protections since 2013 to reduce risk for mortgage holders.3 For example, lenders are now required to complete financial assessments on homeowners before issuing reverse mortgages, and they must provide a three-day grace period to cancel loans following their approval.4 Regulations also limit homeowners’ use of a reverse mortgage to only 60% of the full amount of the loan in the first year.2
Benefits and drawbacks of a reverse mortgage.
Reverse mortgages can increase the cash you have on hand to pay for expenses, help offset poor returns on your other investments, and bridge your income gap if you delay Social Security payments. Note that you’re still responsible for your property taxes, homeowner’s insurance, and upkeep of your home.5
There are drawbacks to a reverse mortgage, however. Depending on your situation, closing costs will probably be higher than a traditional mortgage. Also, if you hope to leave your home for a loved one after you’re gone, a reverse mortgage can use up your equity and deplete your home’s value.5
Finally, even with tightened regulations, you still need to make sure your lender isn’t using your reverse mortgage to sell you other high-priced or inappropriate products to boost their commission and bonus.4
What’s a HELOC?
HELOCs are loans that use your home as collateral. You might think of a HELOC as a credit card for your house. You have a credit limit you can borrow against, pay all or part of the balance, and borrow again up to your limit.6
The length of time you have to borrow from your line of credit and make minimum, interest-only monthly payments is called the draw period. Once it’s over, you’ll have to repay the principal AND interest on your HELOC until the end of your loan period.7
How are they used?
Homeowners use HELOCs to pay for all sorts of expenses, including home repair and renovations, college tuition, big-ticket items like cars, emergencies, and yes, everyday expenses in retirement.8
Most experts agree that HELOCs should be used only for short-term needs in retirement, like paying for unforeseen home or healthcare emergencies, since limited income and cash flow may impact your ability to make your loan payments.9
Benefits and drawbacks of a HELOC.
HELOCs, unlike reverse mortgages, have low interest rates and no closing costs. Your payments are done once your credit line reaches zero.6
Payments are required, however, and if you don’t make them, you could lose your house. And keep in mind, those monthly payments can be high — which may be challenging if you’re on a fixed income.10
Reverse mortgages and HELOCs are intriguing possibilities when it comes to supplementing your income during retirement. Both have benefits as well as drawbacks. It’s a good idea to speak with your financial advisor, an estate lawyer, or a CPA before you commit to either one.
1 Reverse Mortgage Rules & Requirements? American Advisors Group. Retrieved January 22, 2017, from https://www.aag.com/news/reverse-mortgage-rules
2 What’s a reverse mortgage? CNN Money. Retrieved January 22, 2017, from http://money.cnn.com/retirement/guide/retirementliving_homeequity.moneymag/index2.htm
3 Lane, B. (2016, July 15). Study: Recent changes to reverse mortgage rules cut default risk in half. HousingWire. Retrieved January 22, 2017, from http://www.housingwire.com/articles/37546-study-recent-changes-to-reverse-mortgage-rules-cut-default-risk-in-half
4 Consumer Information: Feverse Mortgages. Federal Trade commission. Retrieved January 22, 2017, from https://www.consumer.ftc.gov/articles/0192-reverse-mortgages
5 Reverse Mortgage — What Is It, How Does It Work, And More. (2016, October 10). Bankrate. Retrieved January 22, 2017, from http://www.bankrate.com/finance/retirement/basics-of-reverse-mortgages-1.aspx
6 HELOC. Bankrate. Retrieved January 22, 2017, from http://www.bankrate.com/finance/topic/heloc.aspx
7 What Is a HELOC? (2009, July 24). The Mortgage Professor. Retrieved January 20, 2017, from https://www.mtgprofessor.com/a%20-%20second%20mortgages/what_is_a_heloc.htm
8 Geffner, M. Reasons To Use Home Equity: 5 Good, 1 Bad. Bankrate. Retrieved January 22, 2017, from http://www.bankrate.com/finance/home-equity/reasons-to-use-home-equity-1.aspx
9 Hopkins, J. (2016, April 13). Cash-strapped boomer? Retire on home equity $$. CNBC. Retrieved January 20, 2017, from http://www.cnbc.com/2016/04/13/cash-strapped-boomer-you-can-retire-using-home-equity.html
10 Powell, R. (2012, August 23). Home-equity loans could sink your retirement. MarketWatch. Retrieved January 22, 2017, from http://www.marketwatch.com/story/home-equity-loans-could-sink-retirement-hopes-2012-08-23