Reverse Mortgages, Home Equity Loans And HELOCs: A Guide
As you get older, you might be on a fixed income and looking for ways to provide yourself financial flexibility. As part of that process, you might choose to make use of your home equity. As part of your research, you might be comparing a reverse mortgage vs. a home equity loan.
Another option you might consider is a home equity line of credit (HELOC). Let’s discuss these options so you can make a determination on what’s right for you.
Reverse Mortgage Basics
A reverse mortgage is designed to allow homeowners age 62 and older to tap into their home equity with no monthly mortgage payment – though you are still responsible for paying your taxes and homeowners insurance and maintaining the home. There’s no minimum credit score and the amount you can borrow is based on the age of the youngest borrower or non-borrowing spouse as well as the amount of equity you have.
If you have an existing mortgage, it’s paid off and you get the remainder of the funds that you’re approved for. A financial assessment is conducted to make sure you have the money to handle property taxes, homeowners insurance and maintenance. If necessary, money is set aside from your loan proceeds to handle these expenses.
Reverse mortgages come with fixed or adjustable interest rates, and you can receive your money in one or a combination of several ways.
- Lump-sum payment: You can get your money in one check and use it for whatever expenses you have. This is a fixed-rate option. The rest of these are based on having an adjustable rate.
- Tenure: Equal monthly payments are dispersed as long as you live in the home.
- Term: You receive equal monthly payments for a set period of time.
- Line of credit: You can turn your existing equity into a line of credit so you have money available for projects or other expenses whenever you need. You also have the option of putting money back into the credit line so that you can access it again later.
- Modified tenure: This is a combination of a line of credit and fixed payments for as long as you are in the home.
- Modified term: This combines a line of credit with fixed payments for a certain period.
- Home purchase: Do you want to move closer to the grandkids or downsize your home? You can use the money from a reverse mortgage to purchase a new home without having a monthly mortgage payment. Whether a down payment is required will depend on how much you are approved for.
The most common type of reverse mortgage is a home equity conversion mortgage (HECM). There are other types, including single-purpose and proprietary reverse mortgages, that may be offered by lenders, but HECMs are federally backed by the FHA.
A HECM is a nonrecourse loan, meaning you’ll never owe more than your home is worth. Your heirs are never held responsible for the repayment. Should they want to keep the home after the last remaining borrower or non-borrowing spouse is no longer in it, they can buy it for the balance or 95% of the appraised value, whichever is lower. They can also refinance into a traditional mortgage and stay in the home.
If they don’t want to keep the home, they can sell it and pay off the balance while keeping the remainder of the proceeds. If they don’t want to deal with a sale at all, they can give the property back to the lender without any impact on their credit. It’s important to note that single-purpose and proprietary mortgages may have different terms.
Pros Of A Reverse Mortgage
There are several unique benefits to reverse mortgages.
- No minimum credit score: Your past financial history isn’t held against you.
- No monthly payments: You don’t have a monthly payment. Rather, you’re the one being paid until you’re no longer in the home.
- HECM loans available: Home equity conversion mortgages are federally backed and your heirs aren’t held financially responsible for the loan after you pass.
- Flexibility: You can get the funds as a lump sum payment, monthly payments, a line of credit or even use them to purchase another home.
Cons Of A Reverse Mortgage
There are also drawbacks to this option.
- Costs can add up: In addition to closing costs, there may be servicing fees, fees related to the financial assessment and others. Monthly fees become part of your balance.
- Funds can run out: It’s possible to live long enough to outlive your proceeds or spend them irresponsibly. When this happens, you may not have additional equity to fall back on. Most lenders try to avoid this by requiring that you have a certain amount of equity before taking the loan out. It’s also why, in part, HECM borrowers are required to attend financial counseling.
- Other housing costs: You still have to pay for property taxes, homeowners insurance and maintenance. If you fail to uphold these responsibilities, your loan could come due.
- Confusing loan terms: There are many different types of reverse mortgages, so it’s important to know what you’re getting into. If you’re applying for a federally backed HECM, you’ll go through required financial counseling. Regardless of what you’re considering, it’s not a bad idea to speak to a financial advisor.
Home Equity Line Of Credit (HELOC)
A HELOC is another option for accessing equity that may appeal to you depending on your goals. Let's go over how they work and the pros and cons.
A home equity line of credit (HELOC) is like a credit card with the money drawn from the amount of equity you have. Unlike a reverse mortgage, you have a monthly payment. In fact, this is most often a second mortgage. One of the reasons to take out a HELOC is that you have a really good rate on your existing mortgage and you don’t want to have a higher rate in a cash-out refinance.
Whether it makes sense to do a cash-out refinance or a home equity loan depends on interest rates and the amount you’re looking to take out. Interest rates for home equity loans are higher than those for cash-out refinances because if you default, your primary mortgage holder gets paid first. So it becomes a math problem. A blended rate calculation could help.
A HELOC has two different time frames that are important: the draw and repayment period. During the draw period, you can access as much of your equity as you need up to your approved credit limit to use for projects, investments or expenses. During this time, you’re only responsible for the interest payments, but you can also put money back in to access at a later time.
The second phase is a repayment period. During this time, your balance freezes and you can no longer take money out, but you make principal and interest payments until the end of the term. Like a credit card, HELOCs tend to have variable rates that change monthly.
Pros Of A HELOC
There are several benefits to a HELOC.
- Closing costs: Depending on the lender, closing costs may be significantly lower than some other loan options.
- Lower interest rates than unsecured loans: Interest rates tend to be lower with this type of loan than personal loans or credit cards because your home serves as collateral.
- Flexible payments: At the beginning of the loan, you’re only responsible for interest payments. It may create more room in your budget.
- Flexible spending: During the draw period, you can access as much or as little equity as you need.
- No age requirement: Anyone can get this as long as you qualify and have equity. With a reverse mortgage, you must be 62 or older.
Cons Of A HELOC
HELOCs also have their downsides.
- Credit score requirement: Lenders typically have fairly high credit score requirements. You may need a higher score to access a certain amount of equity no matter how much you actually have in your home.
- Variable interest rates: The interest rates on these work like credit cards. They have the potential to change monthly with market rates.
- Declining equity: As with all of these options, you’re taking equity out of your home. This could pose financial risk if home values decline and you suddenly owe more than your home is worth.
Home Equity Loan
Finally, let’s discuss home equity loans.
Home Equity Loan Basics
A home equity loan works similarly to a cash-out refinance in that you get a lump sum payment. Like a HELOC, it’s typically a second mortgage in addition to your primary mortgage. Your lender can help you with a calculation to determine whether a home equity loan or a cash-out refinance would make more sense.
The home equity loans we offer come with fixed rates. Additionally, you can get a 10- or 20-year term.
Pros Of A Home Equity Loan
Home equity loans have several pros.
- Lump-sum payment: You get all the money at once rather than piecemeal. This is great if you know what you need it for and about how much you can expect to spend.
- Fixed rates are available: Unlike a HELOC, the rates for home equity loans are often fixed so the payment is consistent.
- Long-term loan repayment: Home equity loans can have terms as long as 20 or 30 years.
- Possible tax deductions: If you use the money from a home equity loan to improve upon your property, the interest may be tax deductible. Consult a tax advisor.
Cons of A Home Equity Loan
There are several potential cons to a home equity loan as well.
- High credit score required: As with a HELOC, fairly good credit is necessary and the amount you can borrow is likely to be, in part, impacted by your credit score.
- Fixed repayment schedule: From the beginning of your term, you’ll be making a full principal and interest payment.
- Equity minimum for eligibility: Whether you’re taking out a home equity loan or HELOC, you should be mindful of the fact that you’ll need to leave a certain amount of equity in your home. Given that, you’ll need to make sure you have enough existing equity to accomplish your goals.
Which Loan Type Is Right For You? Reverse Mortgage, Home Equity Loan Or HELOC
Each loan option we discussed to this point has different pluses and minuses. The option you choose is likely to depend on your stage in life, your financial situation and your goals in taking the loan.
How Do You Choose?
Whether a reverse mortgage, HELOC or home equity loan is right for you depends on several factors including what you’re trying to accomplish, your age, interest rates and the loan terms you’re comfortable with. Here’s a comparison table we put together:
Home Equity Loan
Types of interest rates
Fixed and adjustable
Fixed and adjustable
Minimum credit score
When is full repayment due?
When the client or their non-borrowing spouse moves out, sells the home or passes away
End of the term
End of the term
The Bottom Line
Reverse mortgages, HELOCs and home equity loans are three options for accessing your home equity and putting it to work for you. Reverse mortgages are specifically aimed at homeowners aged 62 and older who are looking to access their equity without having a mortgage payment. Heirs have options if they want to keep the property, but they aren’t responsible for taking on your debt.
A HELOC has a draw period and a repayment period. During the draw period, you can take out as much as you need up to the amount of your approval. You can also put money back so you can use it again, but during this time you’re only responsible for the interest. In the repayment period, your balance freezes and you pay back principal and interest for the remainder of the term.
With a home equity loan, this is a lump sum payment like a cash-out refinance. You pay it back over the course of the term. Like a HELOC, a home equity loan is a second mortgage, so the rate is higher than a reverse mortgage would be. You’ll also have two monthly payments with either a HELOC or home equity loan.