But Is There a Better Way to Tap Home Equity?
Comparing a Home Equity Conversion Mortgage (HECM) with cash-out refinancing and other home equity loans.
This may be remembered as The Era of Home Equity. In 2021, homeowners tapped into an all-time record $275 billion in home equity – and $1.2 trillion in cash-out refinancing, which was the most in 16 years and fell just short of a record.1
What exactly is home equity, and why is it so popular?
In the simplest terms, the equity you have in your home is the amount you’ve paid off so far – the difference between your home’s value and what you still owe. As your home value increases and you make more mortgage payments, you build up more equity.
Gaining access to this wealth that’s locked up in your home can be helpful for anyone – but especially for older adults who are approaching, or already in, retirement. Tapping into home equity can generate another source of cash flow for people on fixed incomes, helping them meet everyday expenses and avoid depleting any invested assets.
Another factor in the recent home equity boom is that the current amount of housing wealth in the U.S. is the highest on record: $10.6 trillion of home equity owned by seniors aged 62 and older.2 That’s a lot of money waiting to be used however homeowners see fit: paying off credit cards, making home repairs, helping family members, helping cover health care costs, and much more.
Today, the traditional sources of retirement income – Social Security, pensions, and savings – are no longer sufficient for many to live the retirement lifestyle they envisioned. No wonder more financial advisors are recommending home equity access as a retirement strategy, and more seniors are making it part of their overall financial plans.
How can you tap into your home’s equity?
There are a number of options. Some of the most popular include a cash-out refinance, a home equity loan or line of credit, and a reverse mortgage. Let’s briefly examine each one, then compare how they’re different to help you decide which may be right for you.
The purpose of a cash-out refinance is to withdraw a portion of your home equity as a one-time, lump-sum cash payment. It’s often used to help finance large expenses, such as home renovations or upgrades, college tuition, and more. The result is a new mortgage to replace your old one, possibly with different terms (i.e., lower interest rate or shorter term).
Home Equity Line of Credit (HELOC)
A HELOC lets you borrow against your home’s equity, typically 80%-90% of the full amount. The credit line is open for a specified amount of time (typically 10 years) known as a “draw period,” during which you can borrow as much or as little as needed, up to the credit limit. As you pay it back, the line of credit is replenished, like a credit card. This is also used to fund large expenses, or consolidate debts with high interest rates into one, lower-interest loan.
These home-equity loans are specifically designed for homeowners aged 62 and older. The most common is the Federal Housing Administration (FHA)-insured Home Equity Conversion Mortgage (HECM). It allows you to convert a portion of your home equity into cash to use as you wish. The proceeds are first used to pay off your existing mortgage, and you get the rest – as a lump sum, in monthly payments, as a line of credit, or any combination of the three.
Each of these loan types allow you to access your home equity, but there are some important differences to consider when deciding which one to get.
Who can qualify?
While there are no age restrictions for cash-out refinancing and HELOC loans, you’ll likely be subject to a credit check. Plus, the lender will want assurance that you have an appropriate debt-to-income ratio, so you may be required to show proof of two years of income. For many retirees on a fixed income, these may be daunting hurdles to overcome.
Because the HECM program was designed for seniors, there’s no minimum credit score or income required for a reverse mortgage. In fact, they’re only open to homeowners aged 62 and older who use the home as their primary residence and have built up at least 50% of their home’s equity. You just have to make sure that you can continue to pay property taxes and homeowners insurance, and for home maintenance.
Another benefit of a HECM reverse mortgage is the required, one-time counseling session with a third-party counselor approved by the Department of Housing and Urban Development (HUD). This is to make sure that you fully understand your rights and responsibilities; and get all your questions answered before you make a decision.
How are the loans repaid?
This is where reverse mortgages have a huge advantage. With cash-out refinancing or a HELOC, borrowers must continue to make payments to the lender every month for the life of the loan. But with a reverse mortgage, monthly mortgage payments aren’t required3—so in addition to any cash proceeds you get, you can also eliminate mortgage payments from your monthly budget and redirect the money to cover other expenses.
In fact, as long as you continue to meet your responsibilities as mentioned above, the loan doesn’t come due until you permanently leave the home. Typically, this is done by simply selling the house to cover the loan amount, with any leftover funds going to your heirs. See answers to common questions about reverse mortgages here.
What’s the ideal scenario for each type of loan?
You might consider cash-out refinancing or a HELOC if you have substantial home equity, a steady income, or significant cash flow from your retirement accounts, and are able to absorb the required monthly mortgage payments for the life of the loan.
For older homeowners who want to stay in their homes for the foreseeable future and are looking for a way to supplement their retirement income, reverse mortgages offer a number of significant advantages. Here’s a more detailed comparison of a reverse mortgage line of credit and a HELOC.
Plus, for seniors with homes valued at $400,000 or more, there’s a special kind of reverse mortgage known as a proprietary, or “jumbo”, that allows you to access more cash than a standard HECM and gives you more flexibility than a HELOC. These loans aren’t FHA-insured, but have many of the benefits and safeguards of the standard HECM program. Longbridge Financial has a proprietary reverse mortgage called Longbridge Platinum.
With any reverse mortgage, you can use the proceeds to pay medical bills, increase your cash flow to help pay everyday expenses, make home repairs or upgrades and more—all without having to make monthly mortgage payments.3
Wondering whether a reverse mortgage may the best way for you to tap home equity? Fill out the form on this page to get a free info kit, or call Longbridge at 855-523-4326. There’s no cost and no obligation.
3 Real estate taxes, homeowners insurance, and property maintenance required.