Your Home Mortgage - A Financial Tool
As you pay off your mortgage you are building up equity, or savings, in your home. As your savings accumulate and your needs change, or outside economic factors change, you may want to make changes to your mortgage. Perhaps the most common way that homeowners periodically change their mortgage is by refinancing into a different loan with either different terms (i.e. a fixed interest rate versus a variable interest rate) or a loan with a lower interest rate. Let’s look at some other ways that homeowners periodically choose to change their mortgage or use it as a financial tool:
Taking Out a Home Equity Loan or Line Of Credit
If you have a good history of making your monthly mortgage payment on time and in full, and responsibly use and pay back your other debt (i.e. credit cards, student loans, car loans, etc.) you may be able to take a loan out against the equity (savings) you build up in your home as you pay off your mortgage. This is often also referred to as taking out a “second mortgage.”
A home equity loan is a fixed amount of money lent to you through a lump sum payment that you repay over time through fixed monthly payments. A home equity line of credit (also referred to as a HELOC for Home Equity Line Of Credit) is a revolving line of credit (like a credit card) with a maximum limit against which you can withdraw money. Like a credit card you repay the money you borrow and then can continue borrowing against the principal amount until the line of credit expires, at which point the entire amount must be repaid.
Taking on a second mortgage (either through a loan or line of credit) means that you’re borrowing money and using your home as collateral to qualify for the loan. By offering your home as collateral you are agreeing that the financial institution making you the line or providing the line of credit can take the property (leaving you without a home) if you fail to repay it.
There are numerous reasons people take on home equity debt -- to pay for a child’s college education, for home renovations, for medical bills or other significant expenses.
The amount of money that a financial institution will lend to a homeowner applying for a home equity loan or line of credit depends on two factors - the home’s appraised value and the unpaid balance (UPB) due on the original mortgage.
As with any loan it is critically important to ensure that you understand the terms of the loan or line of credit you’re being extended. Specifically you will want to understand:
- the interest rate you’re being charged – how much, if it’s a fixed or variable rate of interest
- the repayment terms and period
- loan origination costs (i.e. points, home appraisal fee, closing costs, title insurance, taxes, etc.)
- any prepayment penalties
- any additional loan fees (i.e. transaction fees, annual membership fees, etc.)
The federal “Truth in Lending Act” requires that a lender disclose all terms and costs of a home equity loan or line of credit; that information should be provided when you receive the loan application form.
You should carefully review your personal budget to ensure that you’re able to repay the loan according to the terms you’re agreeing to before you sign any documents. Carefully consider what would happen if:
- you or a spouse lost a job or a percentage of your current income?
- your home unexpectedly lost a significant amount of its value and the bank froze or reduced your line of credit or required you to repay the loan before the original due date?
- you needed to move sooner than expected and needed to pay off the loan immediately?
- you needed to, or wanted to rent the home out and that was prohibited under the terms of the loan?
Prepaying Your Mortgage
Pre-paying your mortgage means that you pay your home loan off early – before it’s due. When you prepay your mortgage by sending in additional money toward your principal you will cut years off the life of your mortgage and save on the interest that you would have otherwise paid. You can prepay your mortgage by sending in additional money on a regular or occasional basis. Be sure to note on the check (or online payment) that the money is to be applied directly to the principal. That will ensure that you are paying down the principal amount and not just pre-paying additional interest. Check your mortgage loan paperwork, or ask your lender, to make sure that there are no penalties on prepaying the loan.
Getting a Reverse Mortgage
While you are a homeowner paying off your mortgage you are also building up equity (savings) in your home. As you grow older you may be like the majority of senior homeowners who would prefer to “age-in-place” or live in their own home for as long as possible.
One way to do that and still have enough monthly income to meet regular living expenses is to consider a reverse mortgage. If you and your spouse are 62 or older and own your home, a reverse mortgage can enable you to draw money out of the equity you have built up in your home. Many senior homeowners take out reverse mortgages to make home renovations to accommodate their changing physical needs at home, to pay for medical bills, to start a new business, to pay for a family members’ college education or to supplement a fixed income. You can receive the funds in a one-time lump sum payout, in regular monthly installments, a combination of both a lump-sum payout and monthly installments or a revolving line of credit. A reverse mortgage is still a mortgage – a loan – that either you or your beneficiaries must repay when you leave the home.
By taking on a reverse mortgage you are taking equity out of the house. It’s important to be aware of that if you get into financial difficulty down the road and want to sell the home you will have to pay off the loan when you move out, which will reduce the amount of money you may receive from the proceeds of the home sale. If you owe more to repay the loan than the home’s appraised value you may face having to come up with extra cash in addition to proceeds from the sale of your home to repay the loan in full.
As with any loan it’s critically important that you understand the terms of repayment and the costs associated with borrowing funds (i.e. interest charged on the loan, closing costs, points, origination fee, appraisal fee, etc.) before you sign any documents. Depending on your reason for considering a reverse mortgage you may find that it’s less expensive to find another form of financing such as a home equity loan or line of credit, a personal loan from a bank or credit union, etc.
To learn more about reverse mortgages read information from the following nonprofit sources:
- The National Reverse Mortgage Lenders Association’s online publication “Just the FAQs: Answers to Common Questions About Reverse Mortgages”
- The U.S. Department of Housing & Urban Development (HUD)’s “Top 10 Things to Know If You’re Interested in a Reverse Mortgage” article
- AARP’s publication “Reverse Mortgage Loans: Borrowing Against Your Home”