Key takeaways:
- Both options allow you to borrow money based on the available equity in your home, using the property as collateral.
- A reverse mortgage is a good option if you’re at least 62 years old and don’t need to leave your home to heirs.
- A HELOC is more ideal when you’re younger, don’t need a long-term income source, and you want to pass your home to the next generation.
If you’re a homeowner age 62 or older, you might be wondering how to leverage your home to pay for living expenses and other costs. A reverse mortgage or a home equity line of credit (HELOC) could address those needs. The right decision for you depends on eligibility requirements, how you want to receive the funds, and your plans for the home.
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What is a reverse mortgage?
A reverse mortgage is a type of loan that’s based on the amount of equity you have in your home. You can typically use the money for any purpose like living expenses, existing debts, and medical bills.
The lender gives you the funds, either as one upfront payment or in monthly installments, and adds interest to your balance each month. But instead of making regular monthly payments — as you would with a traditional mortgage — you’re just responsible for maintaining the home. This involves paying property taxes, homeowners insurance, and general upkeep. Then you’ll repay your balance in full when you sell the home or no longer use it as your primary residence. If you pass away, your heirs can repay the balance by selling the home.
The eligibility requirements differ from other types of home loans. With a reverse mortgage, you must be at least 62 years old, use the property as your primary residence, and have a substantial amount of equity in the home — usually at least 50%. You’ll need to fit a few other qualifications as well.
A reverse mortgage can be a good option for older retirees who know how much they need to borrow and want to age in place. These loans tend to “work well for individuals who have few, if any assets, and are not concerned with preserving the equity in their home for the next generation,” says Lawrence Sprung, a certified financial planner and founder of Mitlin Financial.
What is a HELOC?
A home equity line of credit, or HELOC, provides more flexibility compared to a reverse mortgage. You can borrow up to a prespecified credit limit during the draw period, which usually lasts around 10 years, and make interest-only payments on whatever you take out. The line of credit replenishes if you choose to pay down some or all of your principal balance. Then you’ll enter a repayment period, during which time you can’t borrow any more money. You’ll typically pay off the remaining balance over a period of around 20 years.
The amount you can borrow is based on your available home equity. Your home acts as collateral to secure the loan, which means your lender could foreclose on your property if you don't repay the HELOC.
A HELOC “is ideal when there is a short-term need for capital and you are not concerned with having a variable rate,” Sprung says. “(The HELOC) will also allow you to preserve the value of the home, outside of what is being borrowed through the line of credit.”
A home equity loan is similar, since you borrow money based on the equity in your home. But you receive the funds in one payment upfront and repay the balance in fixed installments over several years. Choosing between a home equity loan or a HELOC is usually a matter of figuring out how you want to receive the funds.
Expert tip:
“A home equity loan may be better if you know how much you want to borrow or you need a lump sum, such as to pay off credit cards. You might prefer a HELOC when you expect future costs, but don’t know how much.” — Reina Marszalek, Senior Editor, Mortgages
Reverse mortgages vs. HELOCs: How do they differ?
Both a reverse mortgage and a HELOC use your home’s equity to provide funds. But the qualification requirements, payment structure, and other details vary. Here’s a breakdown of the main differences between reverse mortgages and HELOCs:
Pros and cons of reverse mortgages
While a reverse mortgage offers low qualifications to access the equity in your home, make sure you understand the risks, too:
Pro
- No minimum credit score or income: Lenders may check your financial health and assess the property, but approval is primarily based on your age and the amount of home equity you’ve built.
- No monthly payments: You won’t have to make payments as long as you’re living in and maintaining your home. The balance is due after you pass away or sell the home.
- Manageable loan balance: Your loan balance may eventually exceed the value of your home. But most reverse mortgages are considered “nonrecourse” loans, meaning the lender can’t ask you or your heirs to pay more than the home is worth.
- Tax-free funds: The money you receive from a reverse mortgage isn’t taxable because it’s considered a loan.
- Flexible loan use: You can use the funds from a reverse mortgage for any purpose, such as living expenses, debt repayment, or medical bills.
Cons
- Involves leaving your home: You’ll repay the loan after selling the home, moving out, or passing away (in which case your heirs will need to sell the home and use the proceeds to repay the loan balance).
- Requires substantial equity: You typically need at least 50% equity in the home to take out a reverse mortgage.
- Still possible to lose the home: You can lose the home if you don’t pay property taxes or homeowners insurance, fail to maintain the property, or stop using the home as your primary residence.
- High upfront fees and compounding costs: Borrowers usually pay origination fees, closing costs, and initial premiums upfront. They also have to deal with ongoing monthly costs, like interest and servicing fees, that compound the outstanding loan balance.
Pros and cons of HELOCs
Similarly, if you want to tap into your home’s equity by using a HELOC, make sure you consider the risks and benefits with this type of loan:
Pros
- Flexibility and control: You can borrow the amount you need “on demand,” up to your credit limit.
- Open-ended repayment: You can choose to pay interest only during a “draw” period and clear the balance when you reach the repayment period.
- Lower closing costs: Typically, HELOC closing costs are lower than other home loan products, and you won’t have to buy points.
- Lower equity requirement: A HELOC usually requires you to have 15% to 20% equity left after borrowing funds, which is lower than the reverse mortgage’s 50% requirement.
Cons
- Stricter approval requirements: You’ll typically need strong credit and regular income to qualify for a HELOC, along with enough equity in your home.
- Variable interest rates: HELOCs often come with variable APRs, so the rate you pay can fluctuate with each draw.
- Risk of losing your home: Your lender can seize your property if you default on the HELOC payments.
Which option is better for you?
A reverse mortgage is best if:
- You fit the main eligibility requirements, meaning you’re at least 62 years old and have significant equity in the home.
- You need a continuous income source and don’t want to make regular monthly payments.
- You don’t plan to include your property in your estate plan. Heirs typically sell the home to satisfy the reverse mortgage balance.
- You’re looking to age in place.
A HELOC is best if:
- You’re younger than 62 and you’re looking to tap your home equity.
- You want short-term access to funds as needed and can handle monthly payments.
- You don’t plan to remain in your home as you age.
- You want to leave your home to heirs.
Reverse mortgage vs. HELOC FAQ
What are the eligibility requirements for a reverse mortgage?
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Can I convert a HELOC into a reverse mortgage?
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What are the tax implications of each option?
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