Homeowners have a few options for cashing in the equity in their homes, including reverse mortgages, home equity loans and home equity lines of credit (HELOC). Each of these options works differently and may be better for certain situations. Understanding your needs and how you plan to use the money will help you decide which makes sense for you.
Advantages and disadvantages
Reverse mortgages, home equity loans and HELOCs all let you get cash from the equity in your property. 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.
Pros and cons of a reverse mortgage
A reverse mortgage is a type of loan that older people can take out against their home equity. Reverse mortgages usually pay out as either a lump sum, fixed monthly payments or a line of credit.
Reverse mortgages don’t require repayment until later, usually after the borrower moves, dies or fails to pay their taxes and/or insurance. This is basically the opposite of a traditional mortgage, which requires you to pay off the loan in monthly increments starting immediately. Reverse mortgages are also nonrecourse loans, meaning you and your heirs cannot be held liable if the loan winds up exceeding the value of your home.
- Repayment is not immediate
- Not taxed as income
- Nonrecourse debt
- Age requirements (often 62+)
- Fund use limitations may apply
- Often require 50% equity or more
Pros and cons of a HELOC
A HELOC is somewhat like a credit card, with limits based on the equity you have in your home. You only have to pay interest on the amount of money you withdraw from that line of credit. HELOCs are very flexible, but this flexibility might lead to withdrawing more than you originally intended.
- Flexible use options
- Some options have no closing costs
- Choose how much you borrow
- Potential to overspend
- May require minimum withdrawals
- Variable interest rates common
Pros and cons of a home equity loan
A home equity loan also lets you borrow against the equity you have in your home. Home equity loans are typically disbursed in one single payment.
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 you to pay it back through monthly installments, unlike a reverse mortgage.
- No age limit
- No use restrictions
- Fixed interest rates common
- Closings costs typically from 2% to 5%
- Monthly payments required
- May result in two mortgage payments
Reverse mortgage vs. home equity loan vs. HELOC comparison
It’s important to understand what each option offers. This quick comparison table should help you decide which option is right for you.
|Reverse mortgage||HELOC||Home equity loan|
|Closing costs||Potentially none|
|Flexible uses||Restrictions may apply|
|Reverse mortgage||Restrictions may apply|
|Home equity loan||Possible|
Reverse mortgages, home equity loans and HELOCs are all viable financial solutions, but there are some key differences that might dictate which is right for you.
Interest on a HELOC or home equity loan is not always tax deductible.
The main factors that distinguish reverse mortgages are their age restrictions. Age limits may vary, but reverse mortgage borrowers are generally older people. Home equity conversion mortgages (HECMs) are the most common type of reverse mortgage, but they require borrowers to be at least 62 years old. Other reverse mortgage options may have slightly lower age requirements, but if you’re not near retirement age, a reverse mortgage likely isn’t an option for you.
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.
However, another key difference is that home equity loans often come with fixed interest rates that allow for stable monthly payments. HELOCs commonly feature adjustable interest rates. Combined with their flexible borrowing, this can make your monthly payments change significantly over time.
Which one is best for you?
There are many reasons you might choose one of these options over the others. Here are a few common situations and solutions for each.
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, a home equity loan can be a good solution because you can borrow everything you need immediately.
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 actually need if you practice some discipline.
Bottom line: Which one should I choose?
It’s hard to say. 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 what you need the money for. It’s up to you to make an informed decision based on your personal situation.
As you decide, keep in mind how you would prefer to make payments, what money you have available for closing costs and whether you have enough equity in your home. You can always choose to work with a loan counselor before making the decision.
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