Can you use the proceeds from a reverse mortgage to pay off debt and then refinance the reverse mortgage when your credit score and debt-to-income ratio improve?
One of the main benefits of a reverse mortgage is that there are no restrictions on how you use the proceeds after you pay off your existing mortgage and any other liens on your property. You can invest the money, use it to pay for home renovations and certainly use the finds to pay off or pay down debt.
Using a reverse mortgage eliminates your mortgage payment and if you use the proceeds to pay off other debt such as credit cards, car or personal loans, your monthly cash flow may increase significantly. Lowering your monthly debt expenses also improves your debt-to-income ratio. Plus, paying down your outstanding loan balance may boost your credit score, especially if you are able to close multiple debt accounts.
Please note that you are required to continue to pay property tax and homeowners insurance -- which can be significant expenses -- when you have a reverse mortgage, but you were already responsible for theses costs. By eliminating or significantly reducing your other monthly debt expenses, however, you may be better able to afford your property tax and insurance payments.
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If you have credit challenges such as a low credit score and you want to use the equity in your home to payoff debt, it may be easier to qualify for a reverse mortgage than a standard cash out refinance or home equity loan. Although lenders review your credit history when you apply for a reverse mortgage, unlike a traditional traditional mortgage, your credit score is usually not a determining factor.
You are typically only required to have a credit score of 620 to qualify for a reverse mortgage although a lower score may be permitted for applicants that experienced extenuating circumstances such as job loss or medical illness that negatively impacted their credit. This minimum credit score may be lower than the score required for a refinance, home equity loan or HELOC, depending on the lender and program. Lenders also make sure that you have no late payments or negative credit events over the course of the past year.
Rather than focusing on your credit profile, lenders are more concerned with making sure that you have sufficient equity in your home to qualify for the reverse mortgage. Lenders also verify that you have enough monthly income or assets to afford ongoing non-mortgage housing costs such as property tax, homeowners insurance and homeowners association (HOA) dues or co-op fees, if applicable. Other reverse mortgage qualification requirements include that one borrower must be at least 62 years old and the borrower must live in the property being financed.
Assuming you have enough homeowners equity to pay off your current mortgage and other high interest debt, then using a reverse mortgage may enable you to stabilize your financial situation and better position you to qualify for a refinance in the future.
For example, if you are unable to qualify for a regular refinance today due to credit issues or having too much debt, improving your credit score and lowering debt-to-income ratio may enable you to get approved for a refinance. In short, you may be able to use a reverse mortgage as an interim step to qualify for regular refinance within one-to-two years.
There are several points to keep in mind if you plan to refinance a reverse mortgage. First, your reverse mortgage balance increases every month. So the longer you wait, the less homeowners equity you have, depending on how your property value changes.
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In other words, the more time that passes, the more challenging it becomes to refinance your reverse mortgage because you need to qualify for a higher loan amount each month. Additionally, it may take several months for your credit score to improve after you pay off your debt and close your accounts, so you may not be able to qualify for a refinance right away.
It is also important to highlight that reverse mortgage closing costs are usually higher than the costs for a regular refinance or home equity loan. Although you can finance some of these costs by including them in your loan amount, the costs reduce the proceeds you receive which may limit your ability to pay down debt.
Given the expense involved, it is crucial that you understand how much debt you can pay off to make sure that the reverse mortgage makes sound financial sense. The last thing you want to do is pay for all the costs of a reverse mortgage and not have enough money leftover to pay off your debt.
The good news is that you can pay off a reverse mortgage at any time as long as you qualify for the new mortgage (you can also use proceeds from selling the property or your personal funds). Plus, reverse mortgages do not have a prepayment penalty so there is no extra fee involved when you pay off the loan.
When understood and used properly, a reverse mortgage can enable you to reduce your monthly debt expense, increase your cash flow and improve your financial situation. Reverse mortgages, however, offer both advantages and disadvantages that you should fully consider before you apply.
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Sources
"How the HECM Program Works." Federal Housing Administration. U.S. Department of Housing and Urban Development, 2020. Web.
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