For most people who want to own a home one day, getting a traditional mortgage becomes their only option. However, the United States is currently under a real estate boom with soaring home prices. As such, a large portion of the population can only afford to wait for a market crisis to qualify for a traditional mortgage from the bank. And most the of the younger generation’s parents are continuing to pay for their mortgage loan balance into their late 60s.
Many private lenders and other financial institutions now offer reverse mortgages to fill a market demand for affording a home and navigating retirement living for seniors. Our reverse mortgage specialists at Smartfi Home Loans, LLC will explain the difference between traditional mortgages and reverse mortgage loans in this article.
Traditional Mortgage vs. Reverse Mortgage: An Overview
The reverse mortgage loan refers to one of the newer offerings from the lending industry. They were introduced in the late 1980s and the first FHA-insured HECM was issued in 1989. In comparison, the traditional 30yr fixed was officially authorized by Congress in the late 1940s. Much like emerging financial instruments, such as cryptocurrency and various lines of credit, the real estate market has had a healthy skepticism about its legitimacy.
What Is a Conventional Mortgage?
Traditional or conventional mortgages have been around forever, but taking out a reverse mortgage loan wasn’t really unheard of until the late 2000s.
A conventional mortgage loan is a conforming loan, which means it meets the specific lending and underwriting requirements of Fannie Mae or Freddie Mac.
With a conventional mortgage, you borrow money from the bank to buy or refinance a home. At that point, the borrowers then have a specific monthly mortgage repayment (principal & interest) to the lender over a specific period of time or “term”. Most common terms are a 15 or 30 year mortgage.
Reverse Mortgage Line of Credit vs. a Home Equity Loan
Reverse mortgage loans allow seniors to open a line of credit, or to take out a lump sum of money, against their home’s equity, giving them access to tax-free cash from the equity built up in their home. In simple terms, reverse mortgage loans allow you to borrow against the equity in your home. Your loan proceeds will go directly into your pocket to use however you wish.
Reverse mortgages are unique, and they differ from a home equity line of credit, or HELOC, in a number of ways. While both instruments allow you to borrow against the equity in your home, you have to be a senior to qualify for a reverse mortgage. Also, with a HELOC, the money you borrow comes with a minimum monthly repayment requirement; whereas a reverse mortgage line of credit allows you to defer the repayment. This payment optionality feature can provide an increase in cash flow for retirement.
Traditional mortgages, also called conventional mortgages and forward mortgages, are loans that don’t require backing from a federal government agency. Just like reverse mortgages, traditional mortgages require you to pay property taxes, mortgage insurance premiums if applicable, and homeowners’ insurance. However, unlike a reverse mortgage, you can apply for a conventional mortgage as soon as you turn 18, provided you fulfill the requirements of your chosen lender. With traditional mortgages, you can shop around and compare private lenders to get the best loan agreement possible.
Generally, unless your parents gift you a free-and-clear home in their will, or you strike gold in cryptocurrency or some other business, a traditional mortgage remains the most time-efficient way of building home equity.
When you obtain a mortgage from a lending institution, you co-own the home and typically have little to no equity in it to start. As you make your monthly payments, you decrease the loan amount owed to the lender and start to build home equity. The more money you put into your home, the more equity you build.
Some people may get a traditional mortgage later in life, or end up carrying their debts past their working age, causing strain over their required monthly mortgage payments and little retirement income. If that sounds like you, a reverse mortgage may be a good option for you to alleviate some of the burden and allow you to enjoy your retirement years.
Unlike a conventional mortgage, some reverse mortgages have backing from government institutions, such as the Federal Housing Administration (FHA). The FHA will only insure an home equity conversion mortgage or HECM loan. These loans make up more than half of the reverse mortgage market in America, as retirement becomes more expensive.
Reverse Mortgage Requirements
If your debt management agency recommends you get a reverse mortgage, you might already meet the qualifications. However, if you want to proceed on your own, let’s review some general requirements that must be met:
- You have to be at least 62 years old for a HECM.
- You have to be the titleholder.
- You must have a substantial amount of equity in your home.
- You must be able to pay the ongoing property taxes, homeowners’ insurance, and any HOA fees throughout the mortgage period.
- You must own the property and live in it as your primary residence (meaning you reside at the property consecutively for six months and one day per year).
- You must obtain an acceptable appraisal (done during the loan application process).
Types of Reverse Mortgages
Knowing which type of reverse mortgage to get can make a huge difference. Hundreds of lenders across the United States offer reverse mortgages, here are few types to familiarize yourself with.
Single Purpose Reverse Mortgage
Single-purpose reverse mortgages allow seniors to draw a lump sum amount from their equity for a singular, agreed-upon purpose. You can use these funds for home repairs, mortgage insurance payments, or fulfillment of property taxes.
If borrowers use their reverse mortgage funds for an alternate purpose, they will be liable for fraud. Local government agencies and nonprofits back single-purpose reverse mortgages, so borrowers enjoy lower fees and interest rates.
Home Equity Conversion Mortgages
A home equity conversion mortgage loan has backing from the Department of Housing and Urban Development, and they’re federally insured. You can use the funds from your HECM for any purpose.
The government requires people applying for a home equity conversion mortgage to undergo counseling for a small fee, which they can pay using their loan proceeds. These counseling sessions answer questions, such as “How does a reverse mortgage work?” “Is a reverse mortgage a good idea?” and “Can I find more cost-efficient reverse mortgage alternatives?”
When a lender approves your HECM, you can choose between an array of installment options. These options include a tenure payment scheme, where your lender gives you an agreed-upon lump sum every month for as long as you live in the home, and a term option that gives you cash payment for a pre-set timeframe. Other disbursement options may be available.
Proprietary Reverse Mortgages
A proprietary reverse mortgage helps people with larger estates obtain home equity loans that bypass the $970,800 lending limit of HECMs.
If you go this route, you will not have federal insurance, which means you might be able to borrow more without paying mortgage premiums. The details of this reverse mortgage depends on the interest rates you get, your age, and your income bracket.
Traditional Mortgage vs. Reverse Mortgage: Which One Is Right for You?
Allow one of our licensed loan officers to walk you through a side-by-side comparison of a tailored traditional and reverse mortgage solution to help determine which mortgage is the right fit for you.
If you have more questions about reverse and conventional mortgages, call us at (877) 816-6706 or contact us online today. Our Smartfi Specialists will give you a free mortgage checkup and a no-obligation quote.