Reverse Mortgage vs. Home Equity Loan vs. HELOC: What’s the Difference?

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Reverse Mortgage vs. Home Equity Loan vs. HELOC: What’s the Difference?

Reverse Mortgage vs. Home Equity Loan vs. HELOC: An Overview

If you own a house and are at least 62 years old, you may be eligible to sell your equity for cash to cover living expenses, medical bills, home improvements, or other needs. Reverse mortgages are one option, but homeowners also have access to home equity loans and home equity lines of credit (HELOCs).

All three of these provide you the option to access your home equity without having to sell or vacate your current residence. But since these are distinct loan products, it’s important to be aware of your choices so you can choose the one that’s best for you.

Key Takeaways

  • With a reverse mortgage, the lender compensates you instead of expecting monthly payments as you would with a first mortgage.
  • Any residual equity will be given to you or your heirs when the reverse mortgage lender finally sells the house to recoup the money it paid out to the homeowner.
  • With a home equity loan, the principle and interest are paid in a single lump amount and then over time in monthly payments (which is usually at a fixed rate).
  • Similar to credit cards, HELOCs allow you to draw on your available credit as needed and only pay interest on the amount you actually use. Because they utilize your property as collateral, HELOCs often offer variable interest rates that are lower than those of credit cards.
  • Homeowners must weigh the benefits and drawbacks of each of the three debt instruments to choose the best option for them.

Investopedia / Sabrina Jiang

Reverse Mortgage

A reverse mortgage operates differently from a forward mortgage in that the lender pays you on the basis of a proportion of the value of your house, as opposed to you making payments to the lender. Your debt grows as you make payments and interest builds up over time, but your equity declines as the lender buys more and more of it.

You continue to own the title to your home, but the loan will become due as soon as you sell it, move out of it for a period longer than a year (including an unplanned stay in a hospital or nursing home), or pass away. It will also become due if you stop paying your property taxes and insurance or if the house starts to fall apart. To recoup the money you were given, the lender sells the house (as well as fees).Any remaining home equity belongs to you or your heirs.

Make sure you get the reverse mortgage that best suits your requirements by thoroughly examining the many varieties available. Before you sign up, carefully read the small language with the assistance of a lawyer or tax professional. Older people are often the target of reverse mortgage scams intended to take your home’s equity. The FBI advises against responding to unsolicited ads, being wary of persons who promise to give you a free house, and refusing payments for a house you did not buy.

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It should be noted that if both couples’ names are on the mortgage, the bank cannot sell the home until the survivor passes away or one of the events involving taxes, repairs, insurance, relocation, or home sales is experienced. Before approving a reverse mortgage, couples should thoroughly research the surviving-spouse problem.

There may be further disadvantages as well, such as expensive closing expenses and the chance that your children won’t inherit the family home if they are unable to pay back the loan. In general, interest on a reverse mortgage builds up until the loan is paid off.

Home Equity Loan

A home equity loan allows you to turn your home’s equity into cash, just as a reverse mortgage does. In fact, a home equity loan is sometimes referred to as a second mortgage and functions in the same manner as your main mortgage. You are given the loan in one lump sum payment and are required to make ongoing payments to cover the principle as well as the interest, which is generally charged at a predetermined rate. In contrast to a reverse mortgage, you are not have to be 62 to apply for one, and you must begin making payments on the loan soon after getting it.

Home Equity Line of Credit (HELOC)

You have the choice to take out loans from your home equity line of credit (HELOC) on an as-needed basis up to an authorized credit limit. A HELOC performs more like a credit card in that way.

In the case of a HELOC, interest is only charged on the funds that are actually withdrawn, as opposed to a traditional home equity loan where interest is charged on the total loan amount.

In contrast to a HELOC, which has a variable interest rate, a home equity loan has a fixed interest rate, so you always know what your payment will be.

Currently, the interest you pay on HELOCs and home equity loans is not tax deductible unless you utilize the money for improvements to the house that serves as collateral for the loans. Prior to the Tax Cuts and Jobs Act of 2017, all or a portion of the interest on home equity loans was tax deductible. Remember that this adjustment only applies to tax years 2018 through 2025.

Additionally—and this is a crucial factor in your decision—your property will continue to be an asset for you and your heirs whether you choose a home equity loan or a HELOC. But keep in mind that when your house is used as collateral, you run the danger of losing it to foreclosure if you don’t make your loan payments.

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Key Differences Between Reverse Mortgages, Home Equity Loans, and HELOCs

You may turn your home equity into cash with reverse mortgages, home equity loans, and HELOCs. Although they have similar conditions, such as age, equity, credit, and income, they differ in terms of disbursement and repayment. Here are the main distinctions between the three kinds of loans based on these elements.

Disbursement

  • Reverse mortgage: a line of credit, a lump sum payment, a monthly payment, or a combination of these.
  • lump-sum payment for a home equity loan.
  • HELOC: Available with a credit card, debit card, or a checkbook; as-needed borrowing up to a pre-approved credit limit.

Repayment

  • Reverse mortgage (delayed repayment) loans become due as soon as the borrower stops paying property taxes or insurance, neglects to maintain the house, passes away, or vacates the property.
  • Home equity loans have a fixed interest rate and require regular monthly payments over a certain period of time.
  • HELOCs need minimal monthly payments to cover interest during the draw period and much higher monthly payments dependent on the debt and variable interest rate during the repayment term.

Age and Equity Requirements

  • Reverse mortgage requirements include being at least 62 and having no outstanding mortgage debt or a minor one.
  • Home equity loans: no age restrictions, however the property must have at least 20% equity.
  • HELOC: there is no minimum age restriction, but the house must have at least 20% equity.

Credit and Income Status

  • No income requirements for a reverse mortgage, although some lenders may ask that you demonstrate your ability to pay all continuing property expenses, such as property taxes and insurance, promptly and in full.
  • Good credit and evidence of a consistent income adequate to cover all financial commitments are required for a home equity loan.
  • HELOC: a strong credit rating and evidence of a reliable source of income adequate to cover all monetary requirements

Tax Advantages

  • No reverse mortgage, unless the debt is repaid.
  • Home equity loans are tax deductible for the tax years 2018 through 2025 if they were used for eligible purposes, such as the purchase, construction, or significant improvement of the taxpayer’s secured residence.
  • HELOC: short for home equity line of credit

Factors to Consider

You may turn your home equity into cash with reverse mortgages, home equity loans, and HELOCs. So how can you choose the loan kind that’s best for you?

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Reverse mortgages are generally seen to be a better option if you’re searching for a long-term income source and don’t mind that your house won’t be included in your inheritance. However, if you are married, be sure that the surviving spouse’s rights are understood.

If you need quick money, can afford the monthly payments, and want to maintain your house for your heirs, either a home equity loan or a HELOC is seen to be a preferable choice. Both actions involve considerable hazards in addition to their advantages, so carefully weigh your alternatives before choosing one.

Which Is the Cheapest: Reverse Mortgage, Home Equity Loan, or HELOC?

When compared to reverse mortgages, HELOCs and home equity loans sometimes offer less or no fees and lower or no closing charges. Reverse mortgages often have substantially higher closing fees than conventional mortgages and need mandated counseling sessions.

Which Is the Fastest Money: Reverse Mortgage, Home Equity Loan, or HELOC?

The reverse mortgage will need the most time to complete because of the required counseling sessions, closing disclosures, etc. A HELOC often proceeds a little more quickly than a home equity loan; some lenders advertise closing timeframes of under 10 days. In contrast, the majority of lenders for home equity loans advertise processing periods of two to six weeks.

What Is the Best Option If I Have Bad Credit?

Both a HELOC and a home equity loan have income and credit criteria for approval. Although you won’t need strong credit to get a reverse mortgage, you will need to demonstrate that you can keep the house up and pay the taxes and insurance. You may be able to get a single-purpose reverse mortgage via a nearby nonprofit or government organization if you can’t demonstrate these factors clearly enough to be accepted for a normal reverse mortgage.

The Bottom Line

There is a space for reverse mortgages, HELOCs, and home equity loans. A home equity loan, also known as a HELOC, can be a better choice for you if you are planning to leave your house to your heirs and you have a short-term financial need and the necessary income and credit to be accepted. A reverse mortgage can be the ideal choice for you if you are already retired, need to supplement your income, are unwilling to downsize, and do not want to leave your house to your heirs.

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