Reverse Mortgage vs Downsizing

What a Reverse Mortgage Actually Does for You

A reverse mortgage is a loan against home equity that does not require monthly mortgage payments while the borrower lives in the home. The title stays in the homeowner's name, the Consumer Financial Protection Bureau explains. Federal rules describe it as nonrecourse credit, meaning the borrower is not personally on the hook beyond the home, that comes due, other than in default, only after the consumer dies, transfers the home or stops living there (12 C.F.R. § 1026.33).

The Home Equity Conversion Mortgage, or HECM, is the only reverse mortgage insured by the federal government. It is available only through a lender approved by the Federal Housing Administration (FHA), part of HUD, according to HUD's HECM program page. Under 24 C.F.R. § 206.33, "The youngest borrower shall be 62 years of age or older at the time of loan closing." The full list of reverse mortgage eligibility rules goes further.

Three things come with every HECM. First, interest and fees are added to the balance each month, so the amount owed grows and equity shrinks. Second, the borrower must live in the home as a principal residence (the home lived in for most of the year), pay property taxes and homeowners insurance, and keep the house in good condition. Third, the loan comes due when the last borrower or eligible non-borrowing spouse dies, sells the home, or no longer lives there as a principal residence.

Before a HECM, the borrower must receive counseling from an independent third party not tied to the lender or to sellers of other financial products (12 U.S.C. § 1715z-20(d)(2)(B)). The HUD reverse mortgage counseling session is where alternatives come up.

What Downsizing Really Means

Downsizing means selling the current home and buying or renting a smaller, less expensive or easier-to-manage place. It is the most familiar way to free up equity, and it carries no loan.

The money works simply. The sale price, minus any mortgage still owed and minus the costs of selling, becomes cash. Those selling costs typically include real estate agent commissions, closing costs, any repairs or staging to prepare the home for sale, and moving expenses. Each one reduces what is left.

The new home has its own price. A purchase brings a down payment or full price, along with the usual bills that come with owning. A rental brings monthly rent that can change over time. A retirement community may add monthly service fees. Downsizing is not automatically cheaper. That depends on what the next home costs.

Taxes can matter too. Federal law sets the rules on gains from selling a home, and a tax professional can explain how they apply to a specific sale.

Then there is the part no spreadsheet captures. Leaving means giving up the rooms where a family grew up, the neighbors, the doctor down the road and the daily routines. That loss is real, and it belongs in the decision alongside the numbers.

The numbers and the feelings both belong in this decision, and neither one should be skipped.

Key Differences Between the Two Options

The plainest difference is where you sleep next year. A reverse mortgage is built for staying, as long as the home stays your principal residence and the loan's duties are met. Downsizing requires leaving.

How equity becomes money. A reverse mortgage converts equity into loan proceeds while you remain at home. A lender may pay them as a line of credit, monthly payments for a set term or for as long as you live there as a borrower, or combinations of these, among other methods the statute lists (12 U.S.C. § 1715z-20(d)(9)); how a reverse mortgage works walks through each. Downsizing converts equity once, through the sale.

Ongoing duties. With a reverse mortgage, the costs of owning the home described above remain the homeowner's, and falling behind on them can make the loan due. With downsizing, those responsibilities move to the new property, and may be smaller.

Costs. Both options cost money. A HECM involves closing costs, a mortgage insurance premium (a charge for the FHA insurance on the loan) and interest that keeps adding up. Downsizing involves selling, moving and destination costs.

Heirs. With a reverse mortgage, the loan comes due after the last borrower dies, and the heirs repay it or sell the home to settle it. With downsizing, the estate holds the proceeds and any new home, with no reverse mortgage balance attached.

Undoing it. A HECM may be prepaid in whole or in part at any time without penalty (12 U.S.C. § 1715z-20(d)(4)). A sale is final.

When a Reverse Mortgage May Fit Your Situation

Picture a widow in a paid-off house she loves, with a small pension and little savings. Her wealth is in the walls around her, and she does not want to move. Situations like hers are where a reverse mortgage tends to come up.

For someone in her place, a few things usually line up:

• Staying is the goal. She plans to live in the home for the long term.
• Wealth sits in the house. Savings and other ready money are limited compared with the home's equity.
• The bills are manageable. The home's ongoing costs can be covered for years ahead. A lender may require a set-aside of loan funds for those charges, the CFPB notes.
• The family has talked it through. She understands the balance will grow and has accepted what that means for her heirs.
• Counseling is welcome. She has completed, or is open to completing, the required counseling.

A spouse matters here too. If one spouse is not a borrower but qualifies as an eligible non-borrowing spouse, the loan's due date is generally deferred until that spouse's death, as long as the deferral rules continue to be met (24 C.F.R. § 206.27(c)(3)).

A reverse mortgage is not a fit for everyone. The CFPB warns that if a health issue may cause a move soon, it is an expensive way to cover short-term cash needs (CFPB, "Considering a reverse mortgage?"). The counseling session is one place where that question gets tested.

When Downsizing May Fit Your Situation

Some homeowners are quietly ready. The kids moved out years ago, three bedrooms sit empty, and the roof and gutters feel like a second job. For a person in that place, a move can feel like relief.

For someone in that place, the picture often looks like this:

• A move feels welcome. There is real appetite for a fresh start in a smaller or easier space.
• The house has outgrown its owner. It is larger than needed, and keeping it up has become a burden.
• A clean break appeals. The goal is cash from the equity without a loan balance that grows.
• The estate matters. Passing on as much value as possible to heirs is a priority.
• The next place is clear. A smaller home, a retirement community or a rental is in mind, and its costs have been thought through.

One caution belongs here. The money left after downsizing depends heavily on the local housing market and on what the destination costs. In some places, a smaller home costs nearly as much as a larger one. A local real estate agent can show recent sales, and the new home's monthly costs can be listed before anything is signed.

Other Options Worth Knowing About

Two paths are rarely the only two. Before the choice narrows, the wider set of options is worth a look, each with what it involves and what it trades.

• Home equity loan or line of credit. These borrow against equity with monthly repayment required. They may cost less than a reverse mortgage, the CFPB says, but they usually have monthly payments and depend on income and credit; reverse mortgage vs HELOC compares them closely.
• Cash-out refinance. This replaces the current mortgage with a larger one and pays out the difference in cash. Monthly payments continue, and a long new term can strain a retirement budget, the CFPB cautions.
• Property tax relief. Many localities have programs to help with property taxes, and the CFPB points homeowners to their county or town tax office. Availability and terms vary by place, and the local assessor or tax office publishes current rules.
• Renting out part of the home. A spare room or unit can bring in money without selling or borrowing, while adding the work of being a landlord.
• Help from family. Relatives may share costs or help with upkeep, though informal arrangements work best when everyone agrees on the terms.

There is also a middle path: a HECM for Purchase lets eligible seniors buy a new principal residence and obtain a HECM in one transaction, HUD explains, though it often requires a significant minimum investment. A HUD-approved housing counselor or a financial counselor can help weigh which of these fit.