Table of Contents
Difference Between Reverse Mortgage and Home Equity Line of Credit
Many homeowners wonder what the difference between reverse mortgage and home equity line of credit, and in this article, we are going to cover the key differences to help you decide which is the best option for you.
Individuals with large home equity have several alternatives for accessing funds, including a reverse mortgage, a home equity loan, or a home equity line of credit (HELOC).
Each loan type allows homeowners to use the cash for any purpose; however, each loan type operates differently, and one of these possibilities may be more suited to your financial circumstances.
Before choosing between a reverse mortgage, a home equity loan, or a home equity line of credit, determine which is the best option for your situation.
What is the distinction between a home equity loan, a HELOC, and a reverse mortgage?
Each of these financial products enables homeowners to access the equity in their houses in a unique way.
Each allows homeowners to utilize the funds for any reason, from debt consolidation to bathroom remodeling.
Home equity loan
A home equity loan is frequently referred to as a “second mortgage” because it comes after your primary mortgage. A home equity loan is secured by your home.
The terms are typically five to twenty years, and the maximum loan amount is typically limited to 85 percent of the home’s combined loan-to-value ratio.
Homeowners receive a lump sum that they repay in equal monthly payments at a fixed interest rate, which eliminates the risk of having to make bigger monthly payments when interest rates climb.
Due to the fixed interest rates and monthly payments, this can be advantageous for individuals wishing to budget a specific amount to return each month.
Takeaway: A home equity loan or second mortgage uses your house as collateral and provides you with an upfront lump sum of money along with fixed monthly payments for the duration of the loan.
Who it’s best for: Borrowers having a significant amount of equity and a specified purpose for the funds?
Because you receive a flat payment when you obtain a home equity loan, it is prudent to determine the exact amount you will require beforehand.
HELOC
A home equity line of credit (HELOC) enables homeowners to borrow money against the value of their property and works similarly to a credit card or revolving debt.
A person can access their credit line whenever they require funds for medical or daily expenses, as well as property maintenance.
During the initial phase of the HELOC (referred to as the draw period), you can withdraw funds from the loan and make interest-only payments, which is advantageous if your budget is tight. Typically, the draw duration is five or ten years.
Following that, you enter the payback phase, which typically lasts between 10 and 20 years.
Your payback period payments will include both interest and principal and may be much greater than your draw period payments.
The interest rate on a HELOC is typically variable, which means that payments may increase during some months if interest rates surge or may decrease during rate declines.
Takeaway: A HELOC operates similarly to a credit card, allowing you to spend as much or as little as you need up to the credit line limit.
Who it’s best for: If you’re unsure of the exact amount of money you require, a HELOC may be a smart solution? This is because you will only be charged interest on the amount borrowed.
Reverse mortgage
A reverse mortgage provides the homeowner with either a lump sum payment or monthly payments to supplement their Social Security, pension, or other retirement income for daily and health care needs. To qualify, homeowners must be 62 years of age or older.
A reverse mortgage may be advantageous in some circumstances. Unlike home equity loans, funds obtained through a reverse mortgage are not required to be repaid in monthly installments.
The reverse mortgage proceeds are repaid when the borrower vacates the property, sells it, or dies.
Takeaway: To qualify for a reverse mortgage, you must be 62 years old or older.
Monthly payments are not necessary, but if you miss a payment, interest will accrue until the homeowner vacates the property, sells it, or dies.
Who it’s best for: An elderly homeowner who has paid off their mortgage or has a significant amount of home equity may choose to pursue a reverse mortgage. The benefit of a reverse mortgage is that homeowners can access their home equity in a variety of ways — in the form of a lump amount, regular monthly payments, or a line of credit — without having to make monthly payments.
Things to Avoid
There are a few things to keep in mind while using one of these three methods to access your home equity.
You’ll want to exercise caution to avoid abusing the funds or accruing new credit card debt and sinking further into debt.
By obtaining a loan against your property, you risk ruining years of asset accumulation.
Additionally, taking on debt increases the likelihood that you may be unable to repay it.
Failure to make timely payments may result in penalties, fees, or foreclosure, as well as a blow to your credit score.
This may have an effect on your capacity to borrow money in the future or on your eligibility for low-interest loans.
If you have an adjustable-rate mortgage, your payments may potentially increase in response to rising interest rates.
Interest rates are volatile, and you may end yourself paying significantly more than you expected.
The most typical applications of HELOCs, as well as those advocated by personal finance experts, are to finance costly home renovations and to pay off high-interest credit card debt.
If you use your home equity for any other purpose, you risk falling into financial difficulty.
Difference Between Reverse Mortgage and Home Equity Line of Credit Summary
If you’re considering using some of the equity in your house to fund a purchase, you’ll want to first determine which of these items is suitable for you.
Whichever option you choose, you’ll want to gather vital documents such as your home’s address, tax filings, and evidence of income.
Having those documents on hand will aid in the lending process’s expediency.
Before entering into a reverse mortgage arrangement, a homeowner considering one should speak with a nonprofit agency that provides reverse mortgage counseling.
The National Foundation for Credit Counseling (NFCC) connects seniors with NFCC-certified Home Equity Conversion Mortgage (HECM) counselors who can assist them in making the best decision for their particular circumstances.