Did you know that once you own a home, you still have options for mortgage financing? Even buyers who pay all cash for their home can take out a mortgage, and you have two options – a reverse mortgage vs. a forward mortgage.
A mortgage can be a great personal finance tool to help you reach your financial goals. Whether you have large expenses to pay, debt to consolidate, or you want to supplement your retirement income; there is a mortgage program for you.
Here’s what you should know.
What is a Reverse Mortgage?
A reverse mortgage is for current homeowners. It’s called ‘reverse’ because you don’t make monthly payments. Instead, you receive equity from your home, but you don’t have to make monthly mortgage payments.
It’s like the bank pays you rather than vice versa.
To qualify, you must own your home without a mortgage (or only a small mortgage that you pay off) and be at least 62 years old to qualify. You must also be up to date on your taxes and insurance.
A reverse mortgage pays homeowners the equity in their home in either a lump sum, monthly payments, or as a line of credit. You can also set it up as a combination of several payment options.
Like a forward mortgage, the loan accrues interest, but unlike a forward mortgage, you don’t have to make payments. In addition, homeowners don’t owe any money on their reverse mortgage until they permanently move out of the home or pass away.
A reverse mortgage has closing fees and accrues interest at today’s rates. If you no longer live in the home full-time, you must repay the loan, or your heirs must repay it when you pass away. It’s a non-recourse loan, though, so if the home’s value falls, you won’t owe more than it is worth when you sell it.
The older borrowers are when they take out a reverse mortgage, the more equity they can access. Your loan amount is based on your life expectancy – the younger you are, the longer you have to live, so the less equity you can access, and vice versa.
What is a Forward Mortgage?
A forward mortgage is a traditional mortgage that you use to buy a home, but you can also use it to refinance.
If you want a lower rate, to change your loan’s term, or tap into your home’s equity, you can borrow a forward mortgage.
Unlike a reverse mortgage, forward mortgages accrue interest monthly, and you must make minimum monthly payments. You can borrow a fixed-rate, adjustable-rate, or interest-only forward mortgage.
How Does it Work?
You must prove you have the credit, income, and assets to qualify for a forward mortgage. Lenders will pull your credit, ask for evidence of your income and assets, and calculate your debt-to-income ratio to ensure you can afford the loan.
If you’re refinancing, you must prove your home has adequate equity, you’ve made your mortgage payments on time, and you have the income and assets to support the new loan. In addition, you’ll need money for closing costs on a forward mortgage and room in your budget to make the monthly payments.
What are the Main Differences Between a Reverse Mortgage vs. Forward Mortgage?
The main difference between a reverse mortgage vs. forward mortgage is how it affects your equity.
With a reverse mortgage, your debt increases because interest accrues each month you have an outstanding balance, and your equity decreases each time you receive more money. Think of it as using your home equity now rather than waiting to sell your home or pass the house onto your heirs.
On the other hand, a forward mortgage has decreasing debt and increasing equity. Each month, your payment covers a portion of the loan’s principal and interest charges. You can also make extra principal payments to pay the balance down faster. Each time you make a principal payment, you increase your home’s equity and net worth.
Another large difference between the reverse mortgage vs. forward mortgage is how you qualify. Both have underwriting processes to ensure you can afford the loans, but here’s how they differ:
- Reverse mortgage – You must prove you can afford the taxes, insurance, and home upkeep. You don’t have to prove your income or employment since this loan is for retirees.
- Forward mortgage – You must prove you can afford the monthly payments beyond a reasonable doubt with adequate income and assets and a low enough debt-to-income ratio that shows you can afford the loan.
Who Should use a Reverse Mortgage?
A reverse mortgage is good for retirees who need to supplement their retirement income. You can use the funds to help with monthly expenses, medical expenses, or a special milestone like a dream trip with your family.
To borrow a reverse mortgage, you must prove you can afford the property taxes, home insurance, and the home’s upkeep. You must also undergo HUD-approved housing counseling to ensure you understand the reverse mortgage process.
Who Should Use a Forward Mortgage?
A forward mortgage is for anyone under the age of 62 that wants to tap into their home’s equity, refinance for a lower payment, or eliminate mortgage insurance.
There are more options for a forward mortgage, including conventional, FHA, USDA, and VA loans, giving borrowers with many different backgrounds a chance to own a home and reach their financial goals.
When comparing a reverse mortgage vs forward mortgage, know your options. Compare the overall cost, and look at the monthly payments if you choose a forward mortgage.
Either way, your home is the collateral, so make sure you can keep up with your financial obligations and can enjoy your home while reaching your financial goals.