We get the same question all the time….
“Why should I do a reverse mortgage line of credit instead of a conventional line of credit?”
This post will explain the most substantial differences between the two financing options.
First off, my standard disclaimer (for all the haters that can always find a PROBLEM with every SOLUTION)….
Are you ready for this??? Here is comes….Get ready…..
The Reverse Mortgage is NOT for everyone!!! You heard it here first. Just because your 62 years old, own a home and have a pulse does NOT mean you should do a reverse mortgage.
ALSO….I’m only comparing one of the payment options of the reverse mortgage to a conventional loan. The line of credit. There are other ways to receive the funds from the reverse mortgage that I’m not discussing today (I’d DEFINITELY lose you with all the VERY boringgggg details). We’ll save that for another day.
That being said, the purpose of this post is to explain the differences between the two options to help you decide which one is best for your scenario.
And with no more hesitation…..Here we gooooooo!!!
Difference #1 – Income Qualification
Effective in April 2015, reverse mortgage borrowers are now required to qualify based off of income and credit. So I already hear you saying….
“Eric, how is this different than a conventional “forward” mortgage which requires borrowers to qualify on income and credit?”
GREAT question, and here’s your answer…..
When qualifying for a reverse mortgage, lenders don’t use the same requirements. Income qualification, for instance, is not like a conventional loan approval that uses front end and back end “debt ratios.” In reverse mortgage world, lenders use whats called “residual income.”
“So what’s the difference Eric???”
A debt ratio is calculated by taking all of a borrowers monthly payments and dividing them by their total monthly income (mortgage payment included). The percentage of debts compared to total monthly income gives you a “debt ratio.” Lenders don’t like to see this percentage of total expenses too high. This can be extremely difficult for a borrower that’s probably living off of a fixed income (and maybe some part-time employment income).
On a reverse mortgage, we don’t use “debt ratios.” Instead, we use residual income. In Maryland, and all the way down to Florida, FHA sets the minimum residual income for a one person household at $529 per month. What this means is, after all monthly expenses (mortgage payment NOT included), the borrower must have at least $529 remaining in “residual income”. Just about all sources of income can be used….Social Security, pension, retirement, 401k withdrawals, full time income, part time income, self employed income, rental income, etc..
All this being said, the first (and probably most substantial difference) between a reverse mortgage and conventional mortgage is the income qualification.
Difference #2 – Credit Line Availability and Repayment
On a conventional LOC, a borrower gets access to “X” amount of dollars and that is the max they can draw. They normally have what’s referred to as a “draw” period and a “repayment” period. During the draw period they can access the funds when needed and normally are only required to make interest payments on the amount they’ve drawn. After a certain period of time (5, 7, 10 or 15 years), the loan converts from the interest only “draw” period to the “repayment” period.
This can spell trouble for a borrower that loses access to the available funds and sees a payment go from interest only, to a fully amortized principle and interest payment. This can easily double or triple the minimum interest payment they’ve been making for years.
On a reverse mortgage line of credit, the borrower always has access to the funds in the line of credit and the “draw” period doesn’t end at any specific time. Also, the borrower will never be required to make monthly payments on the money borrowed….EVER.
IN ADDITION to always having access to the funds, reverse mortgage lines of credit also have a built in growth rate. This means that month after month, year after year, the amount the borrower can access goes up!! Regardless of what happens to the value of the home.
Are you starting to see why I’m so excited about reverse mortgages yet????
Difference #3 – Guaranteed Access to Funds
I have rental properties. Years ago, lenders were banging down my door to open up LOC’s on all my properties. I took them up on their offer and opened up lines on all my properties. Why wouldn’t I?
A couple years later, the letters starting coming in the mail.
“We’re sorry to inform you that based on current home values, we’re permanently suspending your line.”
They givith and the taketh. HAHA!!
Why do I tell you all of this? Because on a conventional line of credit the lender can shut down your access to the funds at any time.
Not with a reverse mortgage.
Even if values go down, the line is still available. Even if income goes down, the line is still available. Even if a borrower lives 50 more years (good luck with that), the line is still available.
In a nut shell, the reverse mortgage provides peace of mind for borrowers knowing they can access the money any time, for any reason.
So to wrap all this up, because I’m really starting to bore you (it’s ok, you can admit it), the reverse mortgage MIGHT be a better option for a borrower that has a fixed income, doesn’t want to have to make a monthly mortgage payment, and wants the assurance that funds will always be available.
I’ll close with once again emphasizing that a reverse mortgage MIGHT be a better option than a conventional mortgage (see paragraph above where I intentionally capitalized MIGHT). Talk with a reverse mortgage expert, get the facts, and compare the loans.
I’m done now. 🙂