Home equity loan or HELOC versus reverse mortgage: How to choose

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If you are a homeowner aged 62 and over, you may be weighing your options for accessing your home equity. A reverse mortgage, home equity loan or equity line of credit (HELOC) could provide 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 make loan payments while you are alive. HELOCs and home equity loans do. But repayment is just one of the many factors to consider if you are considering these mortgage products.

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

How mortgages and HELOCs work

Housing equity loans and HELOCs are both second mortgages. With any loan, you can borrow money based on how much equity you have in your home. You will repay the money in monthly installments.

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

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

What you will need to qualify: Mortgage or HELOC requirements 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 share of equity – most lenders will want you to have at least 15% equity in your home.

Understanding mortgages

Mortgage equity loans allow you to borrow against the value of your home and receive a lump sum with a fixed interest rate. You can return the money over a period of up to 30 years.

You should start repaying both the principal and interest within about one month of receiving your loan proceeds.

Understanding of HELOC

HELOCs allow you to borrow any amount up to a certain credit limit. Instead of borrowing money at the same time, you can borrow smaller amounts as you need it. In this way, HELOCs are similar to credit cards.

However, unlike a credit card, which allows you to borrow and repay money indefinitely, HELOC limits borrowing to a specific lottery period – generally between five and 10 years.

Many lenders do not require borrowers to repay any principal during the draw period. Instead, they only ask you to pay interest on what you borrow.

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

How Reverse Mortgages Work

ONE The reverse mortgage gives you cash to spend as you wish. If you still owe money on your first mortgage, you will have to use the reverse mortgage income to repay it and the rest of the income is 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 is the current interest

The balance of a reverse mortgage loan increases over time, but is not due until you die or leave home permanently. Usually, the lender repays by selling the house. Alternatively, the landlord’s heirs can repay the loan and keep the house.

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

  1. Credit line: Similar to a HELOC, you will borrow the amount you need and pay only interest and commissions on what you borrow. Any credit you do not use on your credit line will continue to increase (up to your maximum mortgage amount).
  2. Fixed monthly payments: You will have two options for how to receive your fixed monthly payments. “Term” payments provide payments for as long as you live in your home. “Duration” payments provide payments for a certain number of years.
  3. One-time: You will receive all the money in one and pay interest and commissions for the entire loan amount.

Qualifications for reverse mortgage

You must meet these qualifications to be eligible for a HECM Reverse Mortgage:

  • Be at least 62 years old
  • Own and own a suitable type of property, such as a detached house, as your main residence
  • Be able to afford current property charges, including homeowners insurance, property taxes, and maintenance
  • You own your home without a mortgage or at least 50% of your equity
  • Complete a HUD-approved reverse mortgage counseling session
  • Do not be overdue for any federal debt (such as taxes or student loans)

Advantages and disadvantages of mortgages and HELOCs

The main benefits of mortgages and HELOCs are the relatively low interest rates and the opportunity to borrow a lot of money, while the main disadvantage is that these loans are secured by your home, possibly increasing the risk of foreclosure.

Advantages and disadvantages of a home equity loan

Advantages Disadvantages
Low, fixed interest rate Safe from your home
Fixed monthly payments It must have good credit
Long repayment period The interest increases over time
Low closing costs He must have enough income to qualify

Advantages and disadvantages of a HELOC

Advantages Disadvantages
Borrow as required for up to 10 years Variable interest rate
Fixed monthly payments Non-payment of capital during the lottery period may increase the cost of borrowing
Long repayment period It must have good credit
Low closing costs He must have enough income to qualify

Read more: Fixed Rate HELOC: Crossroads between HELOC and Housing Equity Loans

Advantages and disadvantages of a reverse mortgage

A reverse mortgage loan allows seniors to access the value of their home even if they can not afford the monthly payments or qualify for other types of loans, but it does come at a significant cost.

Advantages Disadvantages
Credit rating is not an approval factor High closing costs
Income is not an approval factor Harder to leave your home to the heirs
No return is required, as long as the house is your main residence Mortgage premiums and monthly service fees
You will never owe more than your home’s worth Variable interest rate on most payment options

I see: Reverse mortgage alternatives: 5 options for seniors

Which option is right for you?

If you can meet the income and credit requirements of a lender, mortgage alternatives such as a mortgage or HELOC will probably be better choices. These loans have a much lower initial cost and are more understandable than reverse mortgages.

Mortgage or HELOC vs. Reverse Mortgage

Mortgage share loan HELOC Reverse mortgage
Min. age of the borrower 18 in most states 18 in most states 62
Access to the cash register One-off As required Lump sum, as needed, or monthly
Interest rate Steady Usually variable but can be corrected Usually variable but can be corrected
Required monthly payments Main and interest Interest only during the draw period. capital and interest during the repayment period No one
Min. credit score Inside the 600 Inside the 600 No one
Equity required Over 20% Over 20% Over 50%

When to Consider a Home Mortgage

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

When to consider a HELOC

  • You can meet your 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 many years of the loan
  • You feel comfortable with a variable interest rate
  • You want to leave your home to your heirs

When to Consider a Reverse Mortgage

  • The equity of your home is your biggest asset
  • You want to grow old in your place
  • You have bad credit
  • You do not want to make monthly payments
  • You are a bigger retiree
  • Are you okay with the lender who is selling your home to repay the loan as soon as you leave or leave life

Suggestion: Even if you are retired, you may be eligible for a second mortgage based on your retirement income from sources such as Social Security, income, a pension or your retirement accounts.

Another option to consider: Cash refinancing

Older homeowners may be interested cash-out refinancing as an alternative means of raising equity.

With cash refinancing, you enter into a new first mortgage that is larger than the rest of your existing mortgage. The income from your new loan pays off your existing mortgage and your closing expenses. You can then save the rest of the money to use as you wish.

Cash refinancing can be a good option when the prevailing mortgage rates are lower than the rate you are currently paying, you have good credit and you can afford the new monthly mortgage payments.

Credible can help you start refinancing with redemption. Checking refinancing rates on our platform is simple and only takes a few minutes – and will not affect your credit score.

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About the Author

Amy Fontinel

Amy Fontinel

Amy Fontinelle is a mortgage and credit card authority and contributor to Credible. Her work has appeared on Forbes Advisor, The Motley Fool, Investopedia, International Business Times, MassMutual and more.

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