Reverse Mortgage vs. Home Equity Loan
While homeownership rates have declined over the past decade across the country, the percentage of American seniors who own a home has stayed remarkably stable. Gallup figures show that 81% of senior citizens owned homes from 2001 to 2009. As of 2017, 82% report owning their own homes. Meanwhile, overall homeownership rates dropped from 71% to 63% between 2009 and 2017.
The driver behind this is simple, the report notes. Many older Americans own their home outright, having paid off their mortgage or downsized to a less-expensive home.
But living debt-free (or close to it) doesn’t mean your life is perfect. After all, retirement often means living on a fixed income. Having your home paid-off may make you feel more secure in old age, but what happens when you need to access to cash?
For many Americans, a home equity loan or home equity line of credit (HELOC) is the answer. However, older Americans who qualify can compare those options to an a different product geared at senior citizens — the reverse mortgage.
While your home may be where you care for your family and retreat from our stressful world, it may also be the largest source of your wealth. Here’s everything you need to know when it comes to deciding on the best way to access your money when you need it.
What is a reverse mortgage?
A reverse mortgage is a type of home loan only available to people age 62 and older who have considerable equity in their property, or own their home outright. A reverse mortgage allows these homeowners to convert part of the equity in their homes into cash, using their home as collateral.
The process works differently than if you took out a traditional home loan. Instead of making monthly payments to a lender, the lender makes payments to the borrower.
There are several different payment plans available, including a lump sum payment, monthly payments, or a line of credit.
The borrower is not required to repay their loan until their home is sold or otherwise vacated. In other words, the borrower can remain in the home without making any payments on their loan until they move to a nursing home, pass away or have to move out on any other terms. In the meantime, however, they are required to keep up with property taxes, homeowners insurance, and HOA dues if applicable.
This type of mortgage was originally conceived in order to help retirees who own their homes cover basic living expenses and the costs of healthcare, said Steve Irwin, the executive vice president of the National Reverse Mortgage Lenders Association. However, there are no restrictions on how reverse mortgage proceeds can be used.
Another benefit: The borrower never gives up the title or ownership of their home with this type of loan. And since the reverse mortgage is a “non-recourse loan,” the borrower never winds up owning more than the value of the home.
The most common type of reverse mortgage is known as a HECM loan, insured by the Federal Housing Authority. To qualify, you will need to:
- Be a homeowner age 62 or older
- Own your home outright or have considerable equity
- Live in your home as your principal address
- Not be delinquent on any federal debts
- Have the resources to keep up with property taxes, insurance, and homeownership association dues if applicable
- Be willing to participate in a consumer information session sponsored by an approved reverse mortgage counselor
Further, the property must be a single-family home, or multi-family home in which the borrower lives in one of the units to be eligible. Some FHA-approved manufactured homes or condo projects are also eligible.
The amount you’re able to receive from your loan amounts depends on a few factors, according to the U.S. Department of Housing and Urban Development:
- The age of the youngest borrower or eligible non-borrowing spouse
- The current interest rate you qualify for
- The appraised value of your home
However, HECM loans have a limit of $726,525.
What is a home equity loan?
A home equity loan is also a way to tap into the value of your home, but it’s dramatically different from a reverse mortgage. With a home equity loan, borrowers are given a lump sum of money and must repay their loan over time. Home equity loans are similar to a first mortgage in the fact that they offer a fixed interest rate, fixed monthly payment and fixed repayment timeline.
There are no minimum age requirements to qualify for a home equity loan. Instead, your ability to qualify depends on how much equity you have in your home, your credit score and credit history and your income. The Federal Trade Commission notes that home equity loans typically only let you borrow up to 85% of your home’s equity, including the new loan and the first mortgage.
Let’s say you own a home worth $300,000, with a $50,000 mortgage left outstanding. You could potentially borrow 85% of the $250,000 in equity, or $212,500.
Reverse mortgage vs. home equity loan comparison chart
|Reverse Mortgage vs. Home Equity Loan|
|Reverse Mortgage||Home Equity Loan|
|Who qualifies?||Homeowners ages 62 with considerable equity in their homes||Borrowers with good or excellent credit with a loan-to-value ratio of less than 85% to 90%, including their new loan amount|
|How is the monthly payment determined?||Reverse mortgages do not require a monthly payment. The amount a homeowner receives depends on the amount borrowed and interest rate||The monthly payment depends on the amount borrowed, interest rate, and repayment term.|
|Interest rates||HECMs usually come with fixed interest rates, although you may have to take a lump sum option to qualify||Interest rates can be as low as 4.25% APR depending on your credit score, how much you borrow, and other factors|
|Credit score requirement||There is no credit score requirement for the FHA-insured HECM mortgage, which is the most popular type||Usually a minimum credit score of 660, although the best interest rates go to those with scores over 700|
|Fees and closing costs||Fees and closing costs can include origination fees, mortgage insurance and other fees. HECM origination fees are capped at $6,000.||Some home equity loans come with origination fees, application or loan processing fees, lender or funding fees, appraisal fees, preparation and recording fees, or broker fees; however, some lenders offer home equity loans without any fees|
When a reverse mortgage might work better
If you’re on the fence about a reverse mortgage and can’t seem to decide whether to opt for a home equity loan instead, there are plenty of factors to keep in mind. Here are some situations when a reverse mortgage might make most sense.
- You’re over the age of 62, own your home outright and are no longer working. Because reverse mortgages let you use the equity in your home to qualify, you don’t need income to qualify for this loan. HECM mortgages also don’t require a minimum credit score to qualify.
- You need supplemental income to enjoy your golden years and keep up with rising costs. If you need to tap into your greatest source of wealth — your home — without having to move, a reverse mortgage can make sense. You’ll receive supplemental income you can use for living expenses or anything else, but you won’t have to vacate your home until you pass away or you need to leave for another reason that has nothing to do with your loan amount.
When a home equity loan might work better
While a reverse mortgage might seem like a better move if you have a lot of equity in your home, there are times when a home equity loan could be a better move — or the only move. Here are some examples:
- You are working and earning income. If you are still working and earning an income, you may be able to qualify for a home equity loan regardless of your age. Compare both reverse mortgages and home equity products to see which one fits better with your needs and your lifestyle.
- You are younger than 62. If you’re under the age of 62, you can’t qualify for a reverse mortgage. You’ll need to consider other loans like home equity loans or home equity lines of credit (HELOCs) if you want to borrow against your home’s equity.
- You want the tax benefits. While you may be able to deduct the mortgage interest on a home equity loan if you use the money for home improvements, you can’t deduct the interest you pay on a reverse mortgage no matter what.
Key considerations when deciding between a reverse mortgage and home equity loan
Still can’t decide between a home equity loan or a reverse mortgage? You may want to speak with a mortgage lender who has expertise on both types of loans. A professional can help you go over the pros and cons of each option as well as all the costs involved.
Key issues you should think over as you decide on your loan include:
- What do you want to happen to your home after you die? According to the FTC, reverse mortgages can use up the equity in your home if you live long enough. These loans are usually non-recourse loans, meaning you can’t owe more than your home is worth. However, your heirs may have the option to pay off the loan and keep the home rather than sell it with a HECM.
- Which loan will have lower lifetime costs? Since some home equity loans come without an origination fee or any other fees, this option can leave you paying lower closing costs. Make sure to compare both types of loans, their closing costs and their lifetime costs if you’re trying to decide.
- Can you keep up with the taxes, insurance, and upkeep on your home? While a reverse mortgage might be tempting, remember that you have to keep up with property taxes, maintenance, homeowners insurance premiums and other costs of homeownership. If your finances are strained and you can’t meet these obligations, you may want to consider other options.
- What about your spouse? Finally, don’t forget about the implications of a reverse mortgage for your spouse. If you take out a HECM loan and you signed the paperwork on your own, your spouse may be able to live in the home after you die provided they keep up with insurance, taxes, and maintenance. However, they won’t continue to receive payments.
The bottom line
The decision between a reverse mortgage and a home equity loan isn’t always an easy one. Both loans let you borrow against the equity in your home regardless of how you plan to use the funds. Plus, both can come with low interest rates and terms depending on your creditworthiness and other factors.
Which option will leave you better off? The best loan for your needs will give you access to the cash you require with low out-of-pocket costs, fair terms, and minimal hassle and stress. Only you can decide, but make sure to do your research first.