Reverse Mortgage vs HELOC: Which Is Better for Me?
If you’re like many people who own a home, your property is your biggest source of wealth. You may not have millions of dollars in a retirement account, but the home equity you have beefs up your net worth — the sum of your assets minus your liabilities.
For example, if you own a home outright that is worth $250,000 and have no other debts, your net worth is at least $250,000. This money may feel “hidden” and beyond your reach, but it still belongs to you.
Fortunately, there are plenty of ways to access this invisible layer of wealth. With a variety of financial products including home equity loans, home equity lines of credit (HELOCs) and reverse mortgage, you can borrow against the equity in your home and get cash for living expenses, home improvement projects or regular bills.
The key to accessing your home equity the right way is figuring out which financial product would benefit you the most. Should you get a HELOC or a reverse mortgage? Each product has its strengths and weaknesses, so it’s best to compare them thoroughly before you decide.
- Comparing reverse mortgages and HELOCs
- Reverse mortgages and HELOCs: What they’re best for
- Pros and cons of reverse mortgages and HELOCs
- Key questions to ask
- Alternative options
- Final thoughts
Comparing reverse mortgages and HELOCs
A reverse mortgage is a type of loan that allows homeowners ages 62 or older to convert part of their home equity into cash. Generally speaking, these loans are set up as lines of credit that make it possible for the borrower to access cash as they need it. Instead of the borrower making payments to the lender on their loan, the lender makes payments to the borrower. When the borrower passes away or moves out, the home is typically sold to repay the loan balance
The borrower is required to keep up with property taxes, homeowners insurance and maintenance on the home, and they have the right to live there until they die or vacate the property otherwise.
The amount of home equity a borrower can access with a reverse mortgage depends on their age, how much home equity they have, the interest rate they qualify for and their ability to cover upfront reverse mortgage costs. The most popular reverse mortgages, called home equity conversion mortgages or HECMS, are offered through the Federal Housing Administration (FHA) and backed by the U.S. government.
With a home equity line of credit, or HELOC, borrowers of any age have the opportunity to access the equity in their homes. Generally speaking, a HELOC will let you borrow up to 85 percent of the appraised value of your home (minus your outstanding mortgage balance) in the form of a line of credit you can borrow against.
With a HELOC, the borrower is required to make monthly payments on their line of credit once they begin borrowing money. Because HELOCs typically come with an adjustable interest rate and the amount of money you access can vary, your monthly payment with a HELOC can fluctuate.
Reverse mortgages and HELOCs: What they’re best for
According to mortgage broker and reverse mortgage specialist Sean Thomas of Ascent Lending, both HELOCs and reverse mortgages can work well for specific types of consumers.
Because reverse mortgages are only for consumers ages 62 and older, they are mostly designed for older individuals and couples who have considerable home equity but need cash to pay typical living expenses in retirement. Thomas said reverse mortgages can provide consumers with a safety net and the cash they need to remain in their home, because reverse mortgages don’t require a monthly payment while the borrower resides at the property.
HELOCs, on the other hand, are meant to be a cheaper alternative to revolving debt like credit cards, Thomas said. This financial product is designed to provide short-term access to the equity in your home and works as a second mortgage.
Since HELOCs require a monthly payment when you borrow against your line of credit, these loans are best for younger people with an income or cash reserves. Thomas said homeowners typically use them to do home improvements, invest in a business or pay off higher interest debt.
Pros and cons of reverse mortgages and HELOCs
While reverse mortgages can be a lifesaver for seniors who have home equity but need cash, they do have drawbacks. The same can be said for HELOCs; they offer easy access to your home equity, but at a cost.
Consider these pros and cons before you choose a reverse mortgage over a HELOC or another financial product.
Reverse mortgage advantages
- Reverse mortgages do not require monthly payments while the borrower remains in the home. Borrowers don’t have to pay it back until the last homeowner dies or moves out, Thomas said. As long as the borrowers maintain taxes, insurance and property upkeep, they are entitled to stay in the home until they die.
- You can increase your income in retirement. Thomas says reverse mortgages are a good way for seniors to add to the income they have set aside for retirement without having to sell their home or move.
- One big advantage of HECM reverse mortgages is that you never have to worry about your loan being underwater, according to Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association. “HECM reverse mortgages are non-recourse loans, which means that neither the borrower nor the heirs will ever owe the lender more than the sale price of the home,” he said. This is true even when the loan balance eventually exceeds the sales price of the home.
Reverse mortgage disadvantages
- Reverse mortgages can be expensive over the long haul when compared with other ways consumers access home equity. Thomas noted that these loans can come with slightly higher interest rates than other financial products. And since you are not actually making payments on the loan, the interest will accrue and add to the total balance that needs to be paid back.
- You may not leave any home equity for your heirs. Thomas noted that, since you are borrowing against your home equity and accruing interest, you may not leave as much wealth to your heirs. Remember that your reverse mortgage loan must be paid back when you die or vacate the property, either through the sale of your home, the proceeds of your estate or some other means.
- It can be a hassle to get out of a reverse mortgage if you change your mind, said Herndon Davis, a mortgage loan officer and real estate agent with Mortgage Real Estate Services in Houston. Typically, you will need to sell your home and repay the reverse mortgage loan balance before you can get access to the home equity you have left. To benefit from a reverse mortgage with minimal hassle and stress, a borrower “must know beyond a shadow of a doubt that the home they’re living in is their forever home,” he said.
- Reverse mortgages come with many of the fees of traditional home loans. Irwin said fees you can expect to pay with a reverse mortgage include:
- an origination fee ($2,500 or 2% of the first $200,000 of the home’s value plus 1% of the amount over $200,000; HECM origination fees are capped at $6,000);
- upfront mortgage insurance premiums of 2% of the home’s appraised value or the FHA lending limit of $679,650 (whichever is less);
- annual mortgage insurance that works out to approximately 0.5% of the outstanding loan balance each year;
- an appraisal fee; and
- typical closing costs such as a credit report fee, flood certification fee, a closing fee, a documentation preparation fee, recording fee, courier fee, title insurance, pest inspection fee and a survey. Irwin noted additional fees may be charged by local governments depending on where you live.
- You have to be ages 62 or older to qualify for a reverse mortgage, so this type of loan isn’t an option for everyone.
- HELOCs tend to be “cheap, flexible credit you can access any time you need it,” Thomas said. Since HELOCs are secured by the equity in your home, they often offer competitive interest rates for those who qualify.
- You can use the funds however you want. Whether you want to consolidate debt, pay for a home remodeling project or help your children pay for college, the line of credit you get with a HELOC can help.
- Since HELOCs are offered as a line of credit, you will only repay the amounts you borrow plus interest and fees.
- While HELOCs come with many of the closing costs of a traditional mortgage including an application fee, title search, appraisal, attorney’s fees and points, these fees are often negotiable. Some lenders also offer HELOCs without many, if any, upfront fees at all.
- You have to make monthly payments on the amounts you borrow until your HELOC is paid off. Irwin also noted that you have to pay interest on your HELOC every month, whereas you can let the interest accrue to be paid off later with a reverse mortgage.
- You need to have an income to qualify for a HELOC because you must be able to demonstrate your ability to repay. This is a departure from the reverse mortgage, where income requirements are looser since there are no monthly payments.
- While HELOC fees and closing costs may be minimal, this is not always the case. You should shop around for a HELOC and compare several lenders in terms of costs and fees before you choose this option.
- A HELOC is a second mortgage that must be repaid. Keep in mind that any time you add new debts to your life, you could be limiting your available cash flow and making it harder to get ahead.
Key questions to ask
Before you decide between a reverse mortgage and HELOC, it helps to ask yourself some important questions about the loan’s purpose, as well as your goals for the future. Questions to ponder as you decide how to move forward should include:
- How do you plan to use the funds you borrow? If you need cash for living expenses, plan to live in your home until you cannot live there any longer and are at least the age of 62, a reverse mortgage can make sense for your goals. If you need cash for debt consolidation, a remodeling project or some other purpose and have an income, on the other hand, a short-term HELOC could make more sense.
- Do you fully understand your borrowing obligations? Whether you opt for a reverse mortgage or a HELOC, it’s important to understand what is expected of you. This includes any fees and closing costs you are expected to pay, along with any monthly obligation to make payments you may have. In the case of a reverse mortgage, you should also understand that the loan will need to be repaid through the sale of your home or other means when you pass away or move from the home.
- Are you on government benefits? Irwin pointed out that while a reverse mortgage will not affect your Social Security or Medicare benefits, the money you receive could affect Medicaid or Supplemental Security Income (SSI) benefits. If you are receiving these government benefits and are considering a reverse mortgage, you should speak to a knowledgeable reverse mortgage loan officer about your specific situation.
- How long do you plan to remain in your home? Especially if you’re considering a reverse mortgage, you need to ask yourself whether your home is your “forever home.” However, you should also ask yourself how long you plan to stay put if you’re taking out a HELOC. With either loan option, you’ll need to repay the funds you borrow plus interest if you plan to sell and move.
- Have I shopped around? Make sure to compare lenders, interest rates and fees before you move forward with a reverse mortgage or a HELOC.
Before you choose between a reverse mortgage and a HELOC, it may be worth it to explore the other options that may be available to you. Financial products to consider can include:
- Home equity loan: A home equity loan lets you borrow against the equity in your home with a fixed interest rate, fixed repayment timeline and fixed monthly payment. The amount you can borrow is typically limited to 85 percent of your home’s value (less your outstanding mortgage balance), and these loans come with fees such as application or loan processing fees, origination or underwriting fees, lender or funding fees, appraisal fees, document preparation and recording fees, and broker fees. Like HELOCs, these loans are available to borrowers of any age, provided they qualify.
- Cash-out refinance: Instead of taking out a second loan on your home, you could also replace your existing home loan with a new loan and take the proceeds out via a cash-out refinance. Cash-out refinance loans tend to come with lower interest rates, because they are a first mortgage. They also come with the typical closing costs you would find with any other first mortgage, which means they will likely be greater than what you would pay with a HELOC or home equity loan.
- Credit card: If you need money in a pinch, an unsecured credit card may also work in your favor. Credit cards come with variable rates and you only need to repay amounts you borrow. Unfortunately, rates tend to be higher than HELOCs or home equity loans since credit cards are not secured by the equity in your home.
Should you get a HELOC, a home equity loan or a reverse mortgage? At the end of the day, only you can decide. While any of these options can help you access the cash you need, the fact each loan works so differently means that one option will likely leave you a lot better off.
Remember to compare options and offers before you pull the trigger on any type of loan to make sure you’re getting the best deal.