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Reverse mortgage vs. home equity loan vs. HELOC

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Reverse mortgages, home equity loans and home equity lines of credit (HELOCs) all allow you to tap into your home equity. Despite this similarity, the three have some key differences, especially in terms of disbursement and repayment. That’s why it’s critical for you to understand the advantages and disadvantages of all three options before making a decision.


Key insights:

  • A reverse mortgage is a good option for older borrowers who want to supplement their retirement income.
  • Home equity loans have the fewest restrictions but can be the costliest option.
  • HELOCs are a line of credit, which makes them ideal for unpredictable costs such as home improvements and medical bills.

What is a reverse mortgage?

A reverse mortgage is a type of loan that older adults can take out against their home equity. The most common type is a Home Equity Conversion Mortgage (HECM), which is backed by the federal government but also has maximum loan limits and specific borrower requirements. Reverse mortgages usually pay out as either a lump sum, fixed monthly payments or a line of credit.

Repayment is not necessary until after the borrower moves, sells, dies or fails to meet lender requirements. Despite not having monthly payments, borrowers must still pay their homeowners insurance, taxes and homeowners association (HOA) fees to avoid defaulting on the loan. Reverse mortgages are also nonrecourse loans, meaning you and your heirs cannot be held liable for loan costs that end up exceeding the value of your home.

Pros and cons of a reverse mortgage

Pros

  • No monthly payments
  • Not taxed as income
  • Never repay more than the value of your home

Cons

  • Age requirements (often 62+)
  • Requires substantial home equity
  • Effects on estate planning

What is a home equity loan?

A home equity loan, often referred to as a second mortgage, is another type of loan that lets you borrow against your home equity. Home equity loans don’t have age requirements, but you must typically have between 15% and 20% equity in your home to qualify. A home equity loan also requires monthly payments on top of your regular mortgage payments.

Home equity loans are typically paid out in one single payment.

Pros and cons of a home equity loan

Pros

  • No age limit
  • No use restrictions
  • Fixed interest rates

Cons

  • Closings costs typically from 2% to 5%
  • Monthly payments required
  • Must have 15% to 20% of equity available

What is a HELOC?

A third common way of borrowing against your home equity is through a HELOC. This is a revolving line of credit that allows you to withdraw up to a lender-established limit as needed. As with a credit card, you only have to repay with interest the amount of money you withdraw from your line of credit. There is a draw period, during which you can withdraw funds and only owe back interest, and a repayment period, when you can no longer take out funds and have to pay back principal and interest.

HELOCs are very flexible and can be used for any expenditure, including home renovations, college tuition and medical expenses.

Pros and cons of a HELOC

Pros

  • Flexible use options
  • Some options have no closing costs
  • Choose how much you borrow

Cons

  • Potential to overborrow
  • May require minimum withdrawals
  • Variable interest rates common

Reverse mortgage vs. home equity loan vs. HELOC comparison

See how a reverse mortgage, home equity loan and HELOC compare side by side:

Reverse mortgageHELOCHome equity loan
Closing costsPotentially none
Age requirements
Flexible usesRestrictions may apply
Income requirements
Tax benefitsPossiblePossible
Reverse mortgageRestrictions may apply
HELOCPotentially nonePossible
Home equity loanPossible

Major differences between reverse mortgage, home equity loan and HELOC

Reverse mortgages, home equity loans and HELOCs are all viable financial solutions when you need access to extra cash, but some key differences might dictate which is right for you.

Age restrictions

Reverse mortgage borrowers have strict age restrictions; in most cases a borrower must be 62 or older. Depending on the lender and type of reverse mortgage, borrowers 55 and older might qualify. HELOCs and home equity loans do not have age restrictions.

Equity restrictions

Borrowers who want to take out a reverse mortgage must own their homes outright or have a low mortgage balance. Most HELOCs and home equity loans require borrowers to have at least 15% to 20% equity in the home.

Disbursement differences

The main difference between home equity loans and lines of credit is how funds are paid out. Home equity loans tend to be paid in lump sums, while HELOCs allow borrowers to withdraw money as necessary. Depending on the reverse mortgage lender, you might have the option for monthly distributions, one lump-sum payment or a line of credit.

Repayment differences

Another key difference is that home equity loans often come with fixed interest rates that allow for stable monthly payments. HELOCs have adjustable interest rates, and you repay only what you borrow from your line of credit; you only owe interest on payments during the draw period, and don’t owe back the principal until the repayment period. Reverse mortgages don’t require any repayment until the borrower moves, sells the home, dies or fails to meet loan requirements.

Which one is best for you?

There are many reasons you might choose one of these options over the others. 

If you have a lot of money in your home: reverse mortgage

Reverse mortgages are a great option when you have a lot of equity in your home. This is because reverse mortgages don’t require monthly payments, so you can continue to enjoy the financial freedom of having your house paid off.

If you have a specific need: home equity loan

With a home equity loan, you have to ask for a certain amount of money. So, if you have a home renovation project that requires upfront cash and you know the exact amount you need, a home equity loan can be a good solution.

If you aren’t sure how much money you need: HELOC

A HELOC is a great choice when you need extra money but don’t want to commit to a specific amount of debt. Many financial advisors recommend HELOCs because they’re more flexible and require less of a financial commitment. This makes it less likely that you’ll take out more than you need — as long as you’re disciplined.

FAQ

Is a reverse mortgage the same as a HELOC?

While both allow you to tap into your home equity, the similarities end there. Reverse mortgages are for older (62 and up) borrowers who have significant home equity and want to tap into that equity and not have to make monthly payments back to the lender. It can come in the form of a line of a lump sum, regular payments or a line of credit, depending on the lender’s payout options.

A HELOC has no age restrictions and requires only 15% to 20% equity. It is similar to a credit card, since the homeowner can take out up to a limit and only has to repay the amount borrowed.

What's the difference between a reverse mortgage and a home equity loan?

The major difference between a reverse mortgage and a home equity loan is that reverse mortgages are only available for older borrowers who own their homes outright or have paid down a significant share of their mortgage, and the borrower doesn’t have to repay the lender until they sell the home, move or die. Home equity loans don’t have age restrictions, but homeowners must have good credit and 15% to 20% or more equity in their homes. Borrowers must also start paying back the lender immediately.

Is there a better option than a HELOC?

There are many HELOC alternatives that might fit your financial needs better. If you know the exact amount of money you need to borrow, a home equity loan might have lower fees. Alternatively, a cash-out refinance might be a better long-term option for saving mortgage costs.

Bottom line

Reverse mortgages, HELOCs and home equity loans are all good financial solutions for homeowners in need of extra cash. However, one option might be a better fit for you, depending on your current financial situation and how you plan to use the money.

As you decide, keep in mind how much equity you have, you plan to use the money, how you prefer to receive the funds and how you prefer to pay back the loan. You can always choose to work with a loan counselor before making a decision.

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