Comparing a Reverse Mortgage vs. a Home Equity Loan or HELOC
Comparing the benefits and drawbacks of a reverse mortgage versus home equity loan or home equity line of credit (HELOC) will come down to your long-term goals, intended use of the funds and current financial situation. While they all allow you to access your home equity for any purpose, each option is structured uniquely, has different costs and comes with its own risks.
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Understanding reverse mortgages, home equity loans and HELOCs
| Loan type | Reverse mortgage | Home equity loan | HELOC |
|---|---|---|---|
| Age requirement | 62 or older | None | None |
| Loan limit | Loan amount is based on the home's value, interest rate and borrower’s age | Up to 85% of your home's value, minus your outstanding mortgage balance | Up to 85% of your home's value, minus your outstanding mortgage balance |
| Minimum credit score | No minimum credit score; however, lender will verify credit history | 620 | 620 |
| Monthly payment | No monthly payment required | Yes; payment varies based on loan amount, interest rate and term | Yes; payment varies based on credit line, outstanding balance, interest rate and term |
| Interest rate type | Fixed or variable, depending on payout option | Fixed | Variable |
| Closing costs | Up to $6,000 in lender fees; 2% of the loan amount for mortgage insurance; and additional fees | 2% to 5% of loan amount | 2% to 5% of loan amount |
| Ongoing fees | 0.5% of loan amount in annual mortgage insurance premiums; servicing fees; interest charges | None | Some lenders charge an annual fee and transaction fees |
Reverse mortgage
Reverse mortgages are a unique type of home equity product available to homeowners ages 62 or older who own their home outright or have a fairly low mortgage balance. Instead of making payments to a lender as with a traditional mortgage, reverse mortgage borrowers receive payouts based on the equity in the home.
Borrowers don’t make reverse mortgage payments as long as they live in the home, but interest and fees are added to the loan balance, causing it to grow and the home equity to decrease. The loan becomes due when the borrower no longer lives in the home, sells it or dies. In most cases, the borrower — or their heirs — sell the property to satisfy the loan balance.
Home equity conversion mortgages offer more payout options
The most common type of reverse mortgage is the home equity conversion mortgage (HECM), insured by the federal government. Other reverse mortgage types include single-purpose reverse mortgages — smaller loans for home improvement or other specified uses — and proprietary reverse mortgages — loans financed by private lenders.
HECM borrowers have multiple payout options, including a single disbursement, fixed monthly payments, a line of credit or a hybrid of monthly payments and a credit line. The payout type determines whether the interest rate is fixed or variable.
Home equity loan
A home equity loan is another option for borrowing against home equity. Borrowers take out a lump sum based on the equity in their home, up to the maximum amount allowed by their lender, and repay the loan in fixed monthly payments over a set term.
To qualify for a home equity loan, borrowers must have enough equity in their house and meet their lender’s income and credit requirements. Typically, home equity loans rates are fixed and home equity terms range from five to 30 years.
Home equity loans are also called second mortgages because, in many cases, borrowers are also repaying a primary home loan.
Home equity line of credit (HELOC)
A HELOC is similar to a home equity loan in that it’s a second mortgage, and borrowers can use HELOC funds for any reason. Also, like a home equity loan, borrowers must meet their lender’s income, credit and loan-to-value (LTV) ratio requirements.
However, how borrowers access and repay a HELOC is different from a home equity loan. With a HELOC, homeowners use the loan proceeds as needed — much like they would a credit card — during a set time frame, called a “draw period.” During the draw period, which typically lasts 10 years, borrowers can make interest-only payments, and during the repayment period, which typically is between 15 and 20 years, they pay principal and interest.
HELOC rates are usually variable.
Which option is best: Reverse mortgage vs. home equity loan vs. HELOC?
While each of these loans gives you access to your home equity for any reason, they suit various needs and circumstances. Review these scenarios to help determine whether a home equity loan, HELOC or reverse mortgage makes sense in your situation.
You should get a reverse mortgage if:
→ You’re at least 62 years old and own your home outright or have significant equity. A reverse mortgage is only an option if you’re 62 or older and have a low mortgage balance.
→ You’re looking for a long-term or ongoing income source. With flexible payout options, a HECM can provide income continuously.
→ You’re looking to supplement your income but don’t want payments. You can tap into your home equity without monthly payments through a reverse mortgage.
→ You don’t plan to pass your home to heirs, or they’re able to buy or sell your home. In many cases, homeowners sell their home to satisfy a reverse mortgage when it’s due. If you understand the risks and aren’t planning to include your home in your estate, a reverse mortgage may work for you.
→ You’re looking to age in place. A reverse mortgage can provide a way to remain in your home and maintain your lifestyle as you get older.
You should get a home equity loan if:
→ You’re under 62 or don’t have enough equity for a reverse mortgage. If you don’t qualify for a reverse mortgage, a home equity loan can provide access to equity.
→ Your need is short term. A home equity loan may work if you’re not looking for an ongoing income source.
→ You have a stable income and can afford the payments. A home equity loan may be a good option if you have a reliable income and can support a second mortgage payment.
→ You’re accessing your equity for home improvement and want the tax benefit. The interest you pay on a home equity loan or HELOC is tax-deductible when using the loan proceeds for home improvement.
→ You want to replenish your home equity. You’ll repay what you borrow and restore your home equity with a home equity loan.
You should get a HELOC if:
→ You’re under 62 and want access to home equity. As with a home equity loan, a HELOC can turn your home equity into cash if you don’t qualify for a reverse mortgage.
→ You have a temporary or short-term need and want to access the funds as needed. While you can tap into your equity as needed with a line of credit reverse mortgage payout option, a HELOC may have fewer fees.
→ You can handle variable payments. Unlike a home equity loan, HELOC payments fluctuate based on how much you borrow and current interest rates.
→ You don’t plan to remain in your home. If you know you won’t be in your home long term, a HELOC may better meet your needs.
→ You have a high credit score. Your credit score will help determine your interest rate on a HELOC or home equity loan. Since HELOCs typically have variable interest rates, you stand to get a competitive rate if you have a good credit score.
6 considerations when choosing a reverse mortgage vs. home equity loan vs. HELOC
Here are the key issues to think about when deciding if a reverse mortgage, home equity line of credit or home equity loan is right for you:
Your age. Besides determining which equity options are available to you, your age will also affect the amount you can borrow. Generally, with a reverse mortgage, the older you are, the more money you can access — taking the loan out too early could mean running out of money.
Total loan costs. You’ll want to compare the upfront and ongoing fees of each option. For example, each loan may have an origination fee, closing costs and interest charges, but reverse mortgages also have an upfront mortgage insurance premium (UFMIP), ongoing mortgage insurance and service fees, and HELOCs may have transaction or annual fees.
Use of funds. What you plan to use the equity for can steer you toward one product or another. For instance, the mortgage interest will be tax-deductible if you use a home equity loan or HELOC for home improvements, but that’s not the case with a reverse mortgage.
The amount available to you. The amount you can borrow will differ with each option based on your home’s value, equity, lender requirements and loan fees. Compare how much you can access with a HELOC versus home equity loan versus reverse mortgage.
Your ability to handle payments and housing costs. You’ll need to consider your capacity for taking on an additional mortgage payment in the case of a home equity loan or HELOC. And keep in mind, with a reverse mortgage, you must still pay your property taxes and homeowners insurance and maintain the property — or else you could risk losing the home. If you can’t meet these obligations, you may want to consider other options to boost your income.
Impact on your spouse. Be sure to consider the implications of a reverse mortgage for your spouse. If you take out a HECM, an eligible non-borrowing spouse may be able to live in the home after you die or move out, provided they keep up with insurance, taxes and maintenance. However, they won’t continue to receive reverse loan payments.