Reverse mortgage vs home equity loan
If you’re 62 or older, own your home outright or have a low mortgage balance, there are two ways to pull cash out of your house without selling it. You can get a home equity loan or line of credit or (HELOAN or HELOC). And you’re probably eligible for a reverse mortgage, often called a home equity conversion mortgage (HECM).
If you have the income and credit to qualify for traditional home equity financing, it’s usually the cheapest money available. It also might be a safer bet for some borrowers.
However, the reverse mortgage has a few advantages as well. It’s important to know the important differences and your situation before deciding.
What is a home equity loan or home equity line of credit?
These are two types of home refinancing or second mortgages. They both require monthly payments, and you need good credit and sufficient income to qualify.
In general, the HELOAN, which usually provides a lump sum at closing and comes with a fixed interest rate, is the best option when you want a large lump sum. Its fixed rate and payment makes budgeting easier. The HELOAN can be great for debt consolidation, or a home addition, or a vacation home or other big purchase.
A home equity line of credit (HELOC) a revolving credit line similar to a credit card. It allows you to draw funds as you need them, up to your credit limit.
HELOCs are great for intermittent needs — for instance, college tuition twice a year, or an extended DIY home improvement project. Its flexibility is an asset, but the changing balance and variable interest rate can make budgeting for the payment a challenge.
What is a reverse mortgage?
Reverse mortgages get their names because they work in reverse. Instead of borrowing a lump sum or using a line of credit and repaying it monthly, you set up your loan and the lender pays you. As long as you live in the home and follow the lender’s guidelines, you don’t have to repay anything.
You can take your loan proceeds in many ways — as a lump sum, fixed payments for a certain number of years, fixed payments for as long as you live in your home, or a line of credit. No matter how large your balance becomes, you cannot be foreclosed or evicted from your house, as long as you honor the terms of the loan.
HECM loans are easy to qualify for because your credit and income are not considered highly-important. It doesn’t matter how much money you have or how good you are at paying bills on time if you’re not required to make regular payments anyway.
Most reverse mortgages (about 90 percent, in fact) are backed by the FHA and contain protections for homeowners. This common reverse loan is called a Home Equity Conversion Mortgage (HECM), pronounced “heck ‘em.”
What are the pros and cons of home equity financing?
The main drawback of home equity loans is that you have to pay them back. Repayment of principal and interest starts immediately. With fixed home equity loans, your payment and rate are generally fixed.
Home equity lines of credit can be trickier. They are cheaper to set up, and more flexible to use, but you can end up with a large balance, less time than you expected to repay it, and higher payments than you can afford.
The key advantage of home equity financing is that it is usually cheaper than the HECM. Setup costs for HECMs include upfront mortgage insurance (.5 to 2.5 percent of your maximum loan amount). That can be very expensive if you borrow a smaller amount or borrow for a shorter term.
HECMs also come with annual insurance, which is calculated at 1.25 percent of the loan balance and added to your loan balance. One reason reverse mortgages can get so expensive (their interest rates are in line with most other mortgage products) is that your balance gets larger over time, not smaller. So your interest charges can pile up.
What are the pros and cons of a HECM or reverse mortgage?
The biggest advantage of the HECM is that in most cases, your income and credit score don’t matter. That’s because you don’t have to make mortgage payments on a reverse mortgage.
That also means you won’t face a higher interest rate than someone with better credit. You can receive the funds for these mortgages in different ways, including lump sum, term payment, tenure payment or line of credit. This flexibility lets you solve all kinds of issues.
However, it can also create problems if you’re not careful — if you receive Supplemental Security Income or Medicaid, avoid getting your proceeds as a lump sum. Otherwise, you could lose these government benefits.
Moreover, if you don’t live in the home full-time (usually after 12 months of absence), your checks will stop and you’ll have to repay the loan. That’s true even you have to leave because of a lengthy illness or you move into a nursing home for full-time care.
You can’t stop paying property taxes, homeowner’s insurance or maintaining the home in good condition, either. If any of those situations arise, you face foreclosure if you don’t pay off the loan first.
Who is the HELOAN or HELOC best for?
If you can qualify for a home equity loan or credit line, it’s probably your best option from an economic standpoint. The HELOAN is best for you if you need a larger lump sum — for consolidating debt, major improvements or big-ticket buys like investment property.
A HELOC is the ideal option for you if you want an emergency credit line or have ongoing, smaller expenses. Its flexibility can help you keep your costs down, because you only pay for what you use.
When is a reverse mortgage or HECM your best option?
A reverse mortgage is for eligible homeowners who need money and can’t qualify for a traditional HELOAN or HELOC. You need supplemental income and want to use your home to provide that income.
You expect to stay in the home until you sell or die. That means you’re in good health and expect to stay in good health. You also can’t plan to spend more than 12 consecutive months away from home, whether traveling or for health reasons.
What are today’s mortgage rates?
Today’s mortgage rates for reverse or home equity loans are very affordable — lower than they have been since the 2016 election. To get the best deal on any loan, get several offers from competing providers, and choose a lender you like from among the most competitive bids.