Reverse Mortgage vs Cash-Out Refinance

Quick Comparison

This table is a general summary. Individual terms vary by lender and by loan, and each row is explained more fully below.

How a Cash-Out Refinance Works

To refinance means to replace an existing mortgage with a new one. A "cash-out" refinance makes the new loan larger than the old balance. The old loan is paid off, and the difference is paid to the homeowner at closing.

After closing, the homeowner makes monthly principal-and-interest payments on the new, larger loan. Principal is the amount borrowed; interest is the lender's charge for lending it. As with a standard mortgage, each payment lowers the balance, which does not grow on its own.

Lenders typically review income, credit score and the loan-to-value ratio, meaning the share of the home's value being borrowed against. The homeowner keeps title, and the home stays the collateral, so missed payments put it at risk.

Closing costs are typical for any refinance. The term is set at the start, commonly 15 or 30 years, and the loan is repaid by the end of the term or when the home is sold. A refinance that changes only the rate or term, without raising the balance, is called a no-cash-out refinance. The Consumer Financial Protection Bureau notes on its alternatives page that taking on a new 30-year mortgage near retirement can become a hardship later.

How a Reverse Mortgage Works

A reverse mortgage is a loan that lets an eligible homeowner draw on home equity with no required monthly principal-and-interest payment. Instead, interest and charges are added to the loan balance, so the amount owed grows over time. The borrower must keep living in the home as a principal residence, pay property taxes and homeowners insurance, and keep the home in good condition. The loan generally comes due when the last borrower dies, sells the home or moves out.

The most common type is the Home Equity Conversion Mortgage, or HECM. It is insured by the Federal Housing Administration, part of the U.S. Department of Housing and Urban Development. HUD's program page says the HECM is the only reverse mortgage insured by the federal government and is available only through an FHA-approved lender.

Under 12 U.S.C. § 1715z-20(d), an insured HECM must be signed by a borrower who "qualifies as an elderly homeowner," which the statute defines as a homeowner who is, or whose spouse is, at least 62, or a higher age the Secretary may set. The regulation, 24 C.F.R. § 206.33, adds that "the youngest borrower shall be 62 years of age or older at the time of loan closing."

The same subsection requires that the borrower "has received adequate counseling" from "an independent third party" not tied to the lender, the loan's funding or the sale of other financial products.

Payment methods listed in the statute include a line of credit, monthly payments over a term the borrower picks, monthly payments over the borrower's tenure, and combinations of these with a line of credit. A reverse mortgage line of credit is one of these. The homeowner keeps title.

Upfront costs include closing costs, an origination fee and a mortgage insurance premium. Federal rules limit the origination fee, which may be fully financed into the loan, and the lender discloses it.

Your Equity Moves in Opposite Directions

Here is the difference that tends to matter most over the years. Equity is the part of the home's value the homeowner owns free of any loan.

With a cash-out refinance, each monthly payment lowers the principal. At any point, the remaining balance is the original loan minus the principal paid so far, and it trends toward zero by the end of the term. Equity rebuilds as the balance shrinks.

With a reverse mortgage, no monthly loan payment is required, so the balance moves the other way. The CFPB's reverse mortgage explainer puts it plainly: "borrowed money + interest + fees each month = rising loan balance." For a HECM, the mortgage insurance premium is part of those added charges. As the balance grows, equity shrinks, unless the home's value rises faster than the balance.

As a hypothetical illustration, picture two homeowners who each borrow the same amount against the same house. Ten years later, the one with the refinance owes less than at the start. The one with the reverse mortgage owes more than was borrowed.

This matters most to heirs who hope to keep the home. With a reverse mortgage, the payoff at the end may be larger than the original amount borrowed. More detail on reverse mortgage balance growth shows how the rate type affects that growth.

Costs, Fees, and What Each Option Involves Financially

Neither option is free. Both carry real costs that reduce the homeowner's equity over time.

Both start with upfront closing costs. With a cash-out refinance, the ongoing cost is the monthly payment. The interest rate is set at closing and may be fixed or adjustable. A higher rate means a larger payment and more total interest over the life of the loan.

With a reverse mortgage, the ongoing cost does not arrive as a bill. Interest and the mortgage insurance premium are added to the balance each month, and no monthly payment goes to the lender. A higher rate makes the balance grow faster. Federal rules set the mortgage insurance premium, and HUD publishes the current figures. The origination fee limit was described above.

For a HECM, 12 U.S.C. § 1715z-20(d) also requires "full disclosure" of all costs, stating "which charges are required to obtain the mortgage and which are not." The FTC's reverse mortgage guidance points to the Total Annual Loan Cost rates, which show "the projected annual average cost of a reverse mortgage." For either loan, a homeowner can ask a lender for a written estimate of costs, such as a Loan Estimate, and compare offers line by line.

When a Cash-Out Refinance Usually Fits

A cash-out refinance tends to fit a homeowner who has reliable income and can comfortably absorb a new, larger monthly payment, now and in the years ahead.

It also tends to fit a homeowner younger than 62, who cannot meet the HECM age rule. A homeowner who wants the balance to go down and equity to rebuild may prefer how a refinance moves.

Time in the home matters too. A homeowner who plans to stay long enough for the benefit to outweigh the closing costs is in a different position from one who may move soon.

Last, a cash-out refinance tends to fit a homeowner whose credit history and income records meet standard mortgage underwriting. Those income and credit requirements mean this option is not available to every homeowner, and a household on a tight fixed income may find the payment hard to carry.

When a Reverse Mortgage Usually Fits

A reverse mortgage tends to fit a homeowner who is at least 62 and lives in the home as a principal residence, the place they live for most of the year.

It may suit a homeowner on a fixed income for whom a new monthly mortgage payment would strain the budget. A homeowner who still owes on a mortgage and wants that payment gone may also look at it: the CFPB says reverse mortgage money can be used to pay off an existing mortgage balance at closing.

It tends to fit someone who plans to stay in the home for the foreseeable future, and who understands and accepts that the balance will grow and equity will shrink. A homeowner who has talked it through with family members who may care about the house later is on firmer ground.

The duties stay in place: living in the home, paying taxes and insurance, and keeping it up. A reverse mortgage is one option among several for an older homeowner with a budget or cash-flow need. Others include a home equity line of credit, downsizing, help from family, and state and local programs that can lower expenses.

Questions Worth Asking Before Choosing Either Option

A decision like this tends to go better when it starts with a few plain questions rather than a product.

• Cash flow. Can the household budget absorb a monthly payment now? What happens to that payment if income drops or care costs rise?
• Timeline. How long does the homeowner expect to stay in the home?
• Heirs. Does the homeowner hope to leave the house to family? Under each option, what would they need to pay to keep it?
• The balance. Is it acceptable for the amount owed to grow, or does it matter that the balance shrink?
• Costs. What does each lender's written cost estimate show, in the same format, for each loan?

For a HECM, independent counseling comes before the loan, as described above. HUD's program page lists the HECM Counselor Roster and a phone line, (800) 569-4287, for finding a counselor. A counselor can go through both options, the reverse mortgage's costs and the alternatives in a single session. An illustration such as a reverse mortgage calculator can help frame questions for that conversation.