Mar 13 2008
Reverse Mortgage Alternatives: Part 4
Refinance and Pull Cash Out
Another alternative may be to pull cash out of your home equity with a traditional mortgage. Why not? Perhaps you should. But first make sure that you fully understand what you're getting and the risks, versus a reverse mortgage.
The two traditional home loan options are the Home Equity Line of Credit (HELOC) and Cash-Out Refinance (CO-REFI). These are loans that are probably offered by every bank in town and are often advertised on their windows. The main difference between the CO-REFI provides you with a one-time lump sum of money and the HELOC gives you much less money, but (like a credit card) you can take out money and put it back in whenever you wish. Some people use these home equity loans to help finance their lifestyle.
So what are the problems for people 62 and older with these loans? The first is that you must qualify for both of them. The qualifying criteria, which determine your interest rate and amount of money that you can get, are all of the following: (1) your credit history and rating; (2) monthly income and amount of cash already in your bank accounts; (3) equity in the home. Now compare those qualifying requirements to those for a reverse mortgage: homeowner's age, location and equity in the home. Now that's more like it!
To get a reasonable amount of money from a traditional mortgage you must have a large enough income (or bank account) to make the required payments for the term of the loan - which is 30 years in some cases. This is why you've heard the saying: "banks only loan money to people who don't need it." In most cases (excepting the reverse mortgage), that's true. If you need the money, you may not qualify for very much. And the less money you get, the quicker you'll run out of it as you spend it on loan payments and your other expenses.
Which brings us to the second and potentially bigger problem: if you're getting a traditional mortgage to help cover expenses, you are using loan proceeds to make the payments. That's called borrowing from Peter to pay Paul - or perhaps more accurately, borrowing from Peter to pay Peter!
In the case of a HELOC, as you use up the money from the loan, your payments will increase sharply. With the CO-REFI, you're paying interest on the FULL amount of the mortgage the month after you take out the loan. So what happens, with either forward mortgage, when you use up all the money and can no longer make the payments? You will be forced to sell your home- or the bank will foreclose and take your house. That's a bit of a dangerous downward spiral, don't you think?
Worse yet, most HELOC's (and many CO-REFI's) have adjustable interest rates. Adjustable rate means adjustable payment. As interest rates rise, your monthly loan payments can rise dramatically. Which brings us back to that dangerous downward spiral.
Stay tuned for more on this topic tomorrow!
