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Reverse Mortgage vs HELOC
Important information you need to know before deciding between a reverse mortgage vs HELOC.
A reverse mortgage, a home equity loan, or a home equity line of credit are all alternatives for those with considerable amounts of equity in their homes.
Homeowners can use the money from each loan for whatever they want; however, each type of loan works differently, and one of these possibilities might be better for your financial circumstances.
Understand which is ideal for your situation before picking between a reverse mortgage, a home equity loan, or a HELOC.
Difference Between a Home Equity Loan, a HELOC, and a Reverse Mortgage?
These three financial tools all assist homeowners in gaining access to the equity in their homes, but in different ways.
Each allows homeowners to put the money toward anything they want, from paying off high-interest credit cards to redoing their bathrooms.
Home Equity Loan
Because it comes after your first mortgage, a home equity loan is commonly referred to as a “second mortgage.” Your home serves as security for a home equity loan.
The periods are normally between five and twenty years, and the amount that can be borrowed is usually limited to up to 85 percent of the total loan-to-value ratio of the home.
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 if interest rates rise.
Because the interest rates and monthly payments are fixed, this can be advantageous for consumers who want to budget a set amount to return each month.
Takeaway: A home equity loan, often known as a second mortgage, is a type of loan that uses your property as collateral and provides you with a predetermined amount of money up front, as well as fixed monthly payments for the duration of the loan.
Who it’s ideal for: Borrowers with a lot of equity who want to use the money for a specified purpose.
Because a home equity loan is paid out in one lump amount, it’s best to know how much you’ll need ahead of time.
HELOC
A home equity line of credit (HELOC) allows a homeowner to borrow money from their home’s equity and works similarly to a credit card or revolving debt.
When a person needs money for medical or daily expenditures, or to make house repairs, they can use the credit line.
You can draw money from the HELOC and make interest-only payments during the first half of the loan (known as the draw period), which can help if you’re on a tight budget. The draw period is normally five or ten years long.
Following that, you’ll begin the payback period, which usually lasts 10 to 20 years.
Your payments will include both interest and principal throughout the payback period, and they may be much greater than the payments made during the draw period.
A HELOC’s interest rate is typically variable, which might result in greater payments during some months if interest rates rise, or lower monthly payments when rates fall.
Takeaway: A HELOC works similarly to a credit card in that you can spend as much or as little as you want up to the credit line limit.
Who it’s ideal for: A HELOC is an excellent alternative if you’re not sure how much money you’ll need to borrow.
This is because you will only be charged interest on the amount you have borrowed.
Reverse mortgage
A reverse mortgage provides a lump sum or monthly payments to the homeowner to supplement their Social Security, pension, or other retirement income for daily and health-care needs.
To apply for one, homeowners must be 62 years old or older.
In some cases, a reverse mortgage may be advantageous. Unlike home equity loans, reverse mortgage funds do not have to be paid back in monthly installments.
When a person chooses to move out, sells their property, or dies, the money acquired from a reverse mortgage is repaid.
Takeaway: To qualify for a reverse mortgage, you must be 62 years old or older.
Monthly payments are not needed, but if you do not make them, interest will accrue until the homeowner vacates the property, sells it, or dies.
Who it’s ideal for: A reverse mortgage might be a good option for an elderly homeowner who has paid off their mortgage or has a lot of equity in their house.
The benefit of a reverse mortgage is that it allows homeowners to access their home equity in a variety of ways, including a lump amount, regular monthly payments, or a line of credit, all without having to make monthly payments.
What to Be Aware Of
When using one of these three methods to access your home equity, there are a few factors to keep in mind.
You’ll want to avoid abusing the funds or accruing new credit card debt, which could lead to further debt.
You could be destroying years of equity buildup by taking out a loan against your property.
Furthermore, taking on debt increases your chances of not being able 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 could impair your future borrowing abilities or your ability to qualify for cheap interest rates.
If you have an adjustable-rate mortgage, your payments may rise when interest rates rise.
Interest rates are volatile, and you could end up paying a lot more than you expected.
HELOCs are most commonly used to pay for expensive home repairs and to pay off high-interest credit card debt, according to personal finance experts.
If you use your home equity for anything else, you could find yourself in financial trouble.
Reverse Mortgage vs HELOC Summary
If you’re thinking about using some of your home’s equity, you’ll need to figure out which of these products is best for you.
Whatever option you select, make sure you have all of your key paperwork on hand, including information on your home, tax returns, and evidence of income.
Having those documents on hand will speed up the loan application procedure.
Before signing a reverse mortgage agreement, a homeowner should speak with a nonprofit organization 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 help them figure out which option is best for them.