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If you are a homeowner and at least 62 years old, you may be able to convert your home equity into cash to pay for living expenses, healthcare costs, home remodeling, or whatever else you need with a reverse mortgage. However, homeowners have other options, including home equity loans and home equity lines of credit (HELOCs).
All three allow you to tap into your home equity without the need to sell or move out of your home. These are different loan products, however, and it pays to understand your options so you can decide which is better for you.
Key Takeaways
- Unlike a first mortgage, for which you make monthly payments to the lender, with a reverse mortgage, the lender pays you.
- A reverse mortgage lender eventually sells the home to recover monies paid out to the homeowner, with any remaining equity going to you or your heirs.
- A home equity loan involves a single lump-sum payment that is repaid in regular installments to cover the principal and interest (which is usually at a fixed rate).
- Like credit cards, HELOCs let you draw on your line of credit when you need it and only pay interest on what you use. HELOCs generally have variable interest rates lower than those of credit cards because they use your home as collateral.
- All three debt instruments have advantages and disadvantages that homeowners need to take into consideration to determine which one is right for them.
Investopedia / Sabrina Jiang
Reverse Mortgage
A reverse mortgage works differently than a forward mortgage—instead of making payments to a lender, the lender makes payments to you based on a percentage of your home’s value. Over time, your debt increases—as payments are made to you and interest accrues—and your equity decreases as the lender purchases more and more of it.
You continue to hold the title to your home, but as soon as you move out of the home for more than a year (even involuntarily for a hospitalization or nursing home stay), sell it, or pass away—or become delinquent on your property taxes or insurance or the home falls into disrepair—the loan becomes due. The lender sells the home to recover the money that was paid out to you (as well as fees). Any equity left in the home goes to you or your heirs.
Study carefully the types of reverse mortgages and make sure you choose the one that works best for your needs. Scrutinize the fine print—with the help of an attorney or tax advisor—before you sign on. Reverse mortgage scams seeking to steal the equity of your home often target older adults. The FBI recommends not responding to unsolicited advertisements, being suspicious of people claiming they can give you a free home, and not accepting payments from individuals for a home you did not purchase.
Note that if both spouses have their name on the mortgage, the bank cannot sell the house until the surviving spouse dies—or the tax, repair, insurance, moving, or selling-the-house situations listed above occur. Couples should investigate the surviving-spouse issue carefully before agreeing to a reverse mortgage.
There can be other drawbacks, too, including high closing costs and the possibility that your children may not inherit the family home if they can’t repay the loan. Interest charged on a reverse mortgage generally accumulates until the mortgage is terminated.
Home Equity Loan
Like a reverse mortgage, a home equity loan lets you convert your home equity into cash. It works the same way as your primary mortgage—in fact, a home equity loan is also called a second mortgage. You receive the loan as a single lump-sum payment and make regular payments to pay off the principal and interest, which is usually a fixed rate. Unlike a reverse mortgage, you don’t have to be 62 to get one, and you have to start making payments on the loan shortly after taking it out.
Home Equity Line of Credit (HELOC)
With a home equity line of credit (HELOC), you have the option to borrow up to an approved credit limit on an as-needed basis. In that regard, a HELOC functions more like a credit card.
With a standard home equity loan, you pay interest on the entire loan amount, but with a HELOC, you pay interest only on the money you actually withdraw.
The fixed interest rate on a home equity loan means you always know what your payment will be, while the variable rate on a HELOC means the payment amount varies.
Currently, the interest you pay on home equity loans and HELOCs is not tax deductible unless you use the money for home renovations or similar activities on the residence that secures the loans. Before the Tax Cuts and Jobs Act of 2017, interest on home equity debt was all or partially tax deductible. Note that this change is for tax years 2018 to 2025.
In addition—and this is an important reason to make this choice—with a home equity loan and a HELOC, your home remains an asset for you and your heirs. It’s important to note, however, that your home acts as collateral, so you risk losing your home to foreclosure if you default on the loan.
Key Differences Between Reverse Mortgages, Home Equity Loans, and HELOCs
Reverse mortgages, home equity loans, and HELOCs all allow you to convert your home equity into cash. However, they vary in terms of disbursement and repayment, as well as requirements, such as age, equity, credit, and income. Based on these factors, here are the key differences among the three types of loans.
Disbursement
- Reverse mortgage: monthly payments, lump-sum payment, line of credit, or some combination of these.
- Home equity loan: lump-sum payment.
- HELOC: as-needed, up to a pre-approved credit limit—comes with a credit card, debit card, or a checkbook.
Repayment
- Reverse mortgage (deferred repayment) loans are due as soon as the borrower becomes delinquent on property taxes or insurance, keeps the home in disrepair, dies, or moves out of the home.
- Home equity loans involve monthly payments made over a set amount of time with a fixed interest rate.
- HELOCs involve minimum monthly payments to cover interest during the draw period and significantly increased monthly payments during the repayment period based on the balance and variable interest rate.
Age and Equity Requirements
- Reverse mortgage: must be at least 62 and own the home outright or have a small mortgage balance
- Home equity loan: no age requirement and must have at least 20% equity in the home
- HELOC: no age requirement and must have at least 20% equity in the home
Credit and Income Status
- Reverse mortgage: no income requirements, but some lenders may check that you can make timely and full payments for ongoing property charges, such as property taxes and insurance
- Home equity loan: a good credit score and proof of steady income sufficient to meet all financial obligations
- HELOC: a good credit score and proof of steady income sufficient to meet all financial obligations
Tax Advantages
- Reverse mortgage: none, until the loan terminates
- Home equity loan: for tax years 2018 through 2025, interest only tax deductible if the money was spent for qualified purposes—to buy, build, or substantially improve the taxpayer’s home that secures the loan
- HELOC: same as for a home equity loan
Factors to Consider
Reverse mortgages, home equity loans, and HELOCs all allow you to convert your home equity into cash. So how to decide which loan type is right for you?
In general, a reverse mortgage is considered a better choice if you are looking for a long-term income source and don’t mind that your home will not be part of your estate. However, if you are married, be sure that the rights of the surviving spouse are clear.
Either a home equity loan or a HELOC is considered a better option if you need short-term cash, will be able to make monthly repayments, and prefer to keep your home for your heirs. Both have considerable risks along with their benefits, so review the options thoroughly before taking either action.
Which Is the Cheapest: Reverse Mortgage, Home Equity Loan, or HELOC?
HELOCs and home equity loans often have fewer or no fees and lower or no closing costs when compared to Reverse Mortgages. Reverse mortgages have mandatory counseling sessions and generally have much higher closing costs than traditional mortgages.
Which Is the Fastest Money: Reverse Mortgage, Home Equity Loan, or HELOC?
The reverse mortgage will take the longest to process with mandatory counseling sessions, closing disclosures, and so on. A HELOC will generally process slightly faster than a home equity loan, with multiple lenders advertising closing times of less than 10 days. By comparison, most home equity loan lenders advertise processing times from two to six weeks.
What Is the Best Option If I Have Bad Credit?
A home equity loan and HELOC both have credit and income requirements for approval. Reverse mortgages don’t require good credit to be approved, but you will have to prove your ability to keep the property maintained and pay your tax and insurance bills. If you can’t prove these sufficiently to get approved for a standard reverse mortgage, you may be able to get a single-purpose reverse mortgage through a local nonprofit or government agency.
The Bottom Line
Reverse mortgages, HELOCs, and home equity loans all have their place. If you temporarily need cash, have the income and credit to get approved, and are looking to leave your home to your heirs, then a home equity loan or HELOC may be a better option for you. If you are already retired and need to supplement your income, are not willing to downsize, and do not want to leave your home to your heirs, then a reverse mortgage may be the best option for you.
