Home Equity Loan or HELOC vs. Reverse Mortgage: How to Choose

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If you are a homeowner and 62 or older, you may be weighing your options for accessing equity in your home. A reverse mortgage, home equity loan, or home equity line of credit (HELOC) could provide you with the cash you need for living expenses, home improvements and repairs, medical bills, or just about any other purpose.

A reverse mortgage does not require you to pay off the loan while you are alive; HELOCs and home equity loans do. But repayment is just one of several factors to consider if you are considering these mortgage products.

Find out how each option works to determine which one best suits your needs:

How Home Equity Loans and HELOCs Work

Home equity loans and HELOCs are both second mortgages. With either loan, you can borrow money based on how much capital you have in your house. You will pay the money in monthly installments.

Since these loans are secured by your home, they have relatively low interest rates. However, second mortgages are considered riskier for lenders than first mortgages.

As a result, you can expect HELOC and home equity rates to be one to two percentage points higher than current mortgage rates.

What you will need to qualify: The Requirements for a Home Equity Loan or HELOC include a credit score in the mid-600s (or higher) and a debt-to-income ratio of 43% or less.

You will also need to have a good portion of the equity in the home; Most lenders will want you to have at least 15% of your home’s equity.

Understanding Home Equity Loans

Home Equity Loans It allows you to borrow against the value of your home and receive a lump sum at a fixed interest rate. You can repay the money within a period of up to 30 years.

You will need to start paying both principal and interest within about a month after receiving the loan proceeds.

Understanding HELOCs

HELOC allows you to borrow any amount up to a set credit limit. Instead of borrowing the money all at once, you can borrow smaller amounts as you need them. In this way, HELOCs are similar to credit cards.

However, unlike a credit card, which allows you to borrow and repay money indefinitely, a HELOC limits loans to a specific withdrawal period, usually between five and 10 years.

Many lenders do not require borrowers to repay principal during the withdrawal period; instead, they only ask you to pay interest on what you have borrowed.

Tip: Most HELOCs have variable interest rates, but you may be able to find a lender that offers a fixed-rate option, which can help you more easily manage your payments and potentially save you money on interest.

How Reverse Mortgages Work

TO Opposite mortgage gives you cash to spend however you want. If you still owe money on your first mortgage, you will have to use the proceeds from the reverse mortgage to pay it off, and the rest of the proceeds are yours.

However, it is not a second mortgage and does not require you to make monthly payments.

The amount you can borrow will be higher depending on:

  • How old are you
  • How much is your house worth
  • How low are the current interest rates

The balance of a reverse mortgage loan grows over time, but it doesn’t expire until you die or permanently move out of your home. Generally, the lender obtains his refund by selling the house. Alternatively, the owner’s heirs can repay the loan and keep the home.

The most common reverse mortgage, a home equity conversion mortgage (HECM), offers payment options in one of three ways:

  1. Credit line: Like a HELOC, you will borrow the amount you need and only pay interest and fees on what you borrow. Any unused credit on your line of credit will continue to grow (up to your maximum mortgage amount).
  2. Fixed monthly payments: You will have two options on how to receive your fixed monthly payments. “Tenancy” payments provide payments for as long as you live in your home. “Installment” payments provide payments over a certain number of years.
  3. Lump sum: You will receive all the funds at once and pay interest and fees on the total loan amount.

Requirements for a reverse mortgage

You must meet these requirements to be eligible for a HECM reverse mortgage:

  • Be at least 62 years old.
  • Owning and occupying an eligible property type, such as a single-family home, as your primary residence
  • Being able to pay for ongoing property expenses, including homeowners insurance, property taxes, and maintenance.
  • Own your home without a mortgage or have at least 50% of your home equity
  • Complete a HUD-approved reverse mortgage counseling session
  • Not be behind on any federal debt (like taxes or student loans)

Pros and Cons of Home Equity Loans and HELOCs

The main benefits of Home equity loans and HELOC are their relatively low interest rates and the opportunity to borrow a lot of money, while the main drawback is that these loans are secured by your home, potentially increasing the risk of foreclosure.

Pros and Cons of a Home Equity Loan

Pros Cons
Fixed and low interest rate Insured by your home
Fixed monthly payments Must have good credit
Long payback period Interest accumulates over time
Low closing costs You must have enough income to qualify

HELOC pros and cons

Pros Cons
Borrow as needed for up to 10 years Variable interest rate
Fixed monthly payments Not paying principal during the retirement period can increase borrowing costs
Long payback period Must have good credit
Low closing costs You must have enough income to qualify

Pros and cons of a reverse mortgage

A reverse mortgage loan allows seniors to access their home equity even if they cannot afford monthly payments or qualify for other types of loans, but it carries considerable costs.

Pros Cons
Credit score is not an approval factor High closing costs
Income is not an approval factor More difficult to leave your home to the heirs
No refund is required as long as the home is your primary residence Mortgage Insurance Premiums and Monthly Service Fees
You will never owe more than your house is worth Variable interest rate on most payment options

Watch: Reverse Mortgage Alternatives: 5 Options for Seniors

Which option is correct for you?

If you can meet the credit and income requirements of a lender, reverse mortgage alternatives such as a home equity loan or HELOC will probably be better options. These loans have much lower startup costs and are easier to understand than reverse mortgages.

Home equity loan HELOC Opposite mortgage
Min. Age of borrower 18 in most states 18 in most states 62
Access to funds Lump sum As necessary Lump sum, as needed or monthly
Interest rate Repaired Generally variable but can be arranged Generally variable but can be arranged
Monthly payments required Principal and interest Interest only during the withdrawal period; principal and interest during the amortization period Neither
Min. Credit score Mid-600s Mid-600s Neither
Equity required More than 20% More than 20% More than 50%

When to consider a home equity loan

  • May meet credit and income requirements.
  • You want predictable monthly payments
  • You need a lump sum for a specific purpose
  • You want to leave your house to your heirs

When to consider a HELOC

  • May meet credit and income requirements.
  • You want the flexibility to decide when to borrow and how much
  • You want to make interest-only payments for the first few years of the loan
  • You are comfortable with a variable interest rate
  • You want to leave your house to your heirs

When to consider a reverse mortgage

  • Your home equity is your greatest asset
  • You want to grow old in the place
  • You have bad credit
  • You don’t want to make monthly payments
  • You are a senior retiree
  • You agree to the lender selling your home to pay off the loan once you move or die

Tip: Even if you are retired, you may still qualify for a second mortgage based on your retirement income from sources like Social Security, annuities, a pension, or your retirement accounts.

Another option to consider: refinancing with cash withdrawal

Older homeowners may be interested in refinancing with cash withdrawal as an alternative means of leveraging home equity.

With a cash-out refinance, you get a new first mortgage that is greater than your current mortgage balance. The proceeds from your new loan pay for your existing mortgage and closing costs. Then you can keep the rest of the money to use it however you want.

A cash-out refinance may be a good option when your prevailing mortgage rates are lower than the rate you are currently paying, you have good credit, and you are able to afford the new monthly mortgage payments.

Credible can help you get started with your cash withdrawal refinance. Checking refinance rates on our platform is simple and only takes a few minutes, and it won’t affect your credit score.

Get the cash you need and the rate you deserve

  • Compare Lenders
  • Get cash to pay off high-interest debt
  • Prequalify in just 3 minutes

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About the Author

Amy fontinelle

Amy Fontinelle is a credit card and mortgage authority and contributor to Credible. His work has been featured in Forbes Advisor, The Motley Fool, Investopedia, International Business Times, MassMutual, and more.

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