Home equity loan or HELOC or reverse mortgage: how to choose

Home equity loan or HELOC or reverse mortgage: how to choose

Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, which we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to herein as “Credible”.

If you’re a homeowner and you’re 62 or older, you may be considering your options for accessing the equity in your home. A reverse mortgage, home equity loan, or home equity line of credit (HELOC) could provide the money you need for living expenses, home improvements and repairs, medical bills, or almost any other goal. .

A reverse mortgage does not require you to make any payments on your loan while you are alive; HELOCs and home equity loans do. But repayment is just one of many factors to consider when considering these mortgage products.

Learn how each option works to determine which one best suits your needs:

How Home Equity Loans and HELOCs Work

Both home equity loans and HELOCs are second mortgages. With either loan, you can borrow money based on the equity in your home. You will repay the money in monthly installments.

Since these loans are secured by your home, they have relatively low interest rates. However, second mortgages are considered riskier for lenders than first mortgages.

As a result, you can expect HELOC rates and home equity to be one or two percentage points higher than current mortgage rates.

What you will need to qualify: The requirements for getting a home equity loan or HELOC include a credit score in the mid-600s (or higher) and a debt-to-income ratio of 43% or less.

You will also need to have a fair amount of equity in your home – most lenders will want you to have at least 15% equity in your home.

Understanding Home Equity Loans

Home equity loans allow you to borrow against the equity in your home and receive a lump sum at a fixed interest rate. You can repay the money over a term as long as 30 years.

You will need to start repaying principal and interest within approximately one month of receiving your loan proceeds.

Understanding HELOCs

HELOCs allow you to borrow any amount up to an established credit limit. Instead of borrowing the money all at once, you can borrow smaller amounts as you need them. In this way, HELOCs are similar to credit cards.

Unlike a credit card, however, which allows you to borrow and repay money indefinitely, a HELOC limits borrowing to a specific drawdown period – usually between five and 10 years.

Many lenders do not require borrowers to repay principal during the drawdown period; instead, they only ask you to pay interest on what you’ve borrowed.

Point: Most HELOCs have variable interest rates, but you may be able to find a lender that offers a fixed rate option, which can help you manage your payments more easily and potentially save you some money. interests.

How Reverse Mortgages Work

A The reverse mortgage gives you money to spend as you see fit. If you still owe money on your first mortgage, you will need to use the reverse mortgage proceeds to pay it off, and the remaining proceeds are yours.

However, it is not a second mortgage and does not require you to make monthly payments.

The amount you can borrow will be higher depending on:

  • How old are you
  • How much is your house worth
  • How low are current interest rates?

The balance of a reverse mortgage increases over time, but is not due until you die or move out of your home for good. Usually the lender is repaid by selling the house. Alternatively, the owner’s heirs can repay the loan and keep the house.

The most common reverse mortgage – a home equity conversion mortgage (HECM) – offers payment options in one of three ways:

  1. Credit line: Similar to a HELOC, you will borrow the amount you need and only pay interest and fees on what you borrow. Any unused credit in your line of credit will continue to grow (up to the maximum amount of your mortgage).
  2. Fixed monthly payments: You will have two choices for receiving your fixed monthly payments. “Occupancy” payments provide payments for as long as you live in your home. “Term” payments provide payments for a number of years.
  3. Lump sum: You will receive all funds at once and pay interest and fees on the total loan amount.

Qualifications for a Reverse Mortgage

You must meet these conditions to qualify for a HECM reverse mortgage:

  • Be at least 62 years old
  • Own and occupy a qualifying property type, such as a single-family home, as your principal residence
  • Be able to pay regular property charges, including home insurance, property taxes, and maintenance
  • Own your home mortgage-free or own at least 50% of the equity in your home
  • Complete a HUD-approved reverse mortgage counseling session
  • Not be overdue on any federal debt (like taxes or student loans)

Advantages and Disadvantages of Home Equity Loans and HELOCs

The main advantages of home equity loans and HELOCs are their relatively low interest rates and the ability to borrow a lot of money, while the main disadvantage is that these loans are secured by your home, potentially increasing your seizure risk.

Advantages and disadvantages of a home loan

Benefits The inconvenients
Low and fixed interest rate Secured by your home
Fixed monthly payments Must have good credit
Long repayment period Interest accrues over time
Low closing costs Must have sufficient income to qualify

Advantages and disadvantages of a HELOC

Benefits The inconvenients
Borrow as needed over a maximum of 10 years Floating interest rate
Fixed monthly payments Non-payment of principal during the drawdown period may increase borrowing costs
Long repayment period Must have good credit
Low closing costs Must have sufficient income to qualify

Read more: Fixed Rate HELOC: A Cross Between HELOCs and Home Equity Loans

Advantages and disadvantages of a reverse mortgage

A reverse mortgage allows seniors to access the value of their home even if they can’t afford monthly payments or qualify for other types of loans, but it comes with significant costs.

Benefits The inconvenients
Credit score is not an approval factor High closing costs
Income is not an approval factor More difficult to leave your house to your heirs
No repayment required as long as the house is your principal residence Mortgage insurance premiums and monthly service fees
You will never owe more than your house is worth Variable interest rate on most payment options

To see: Reverse mortgage alternatives: 5 options for seniors

Which option suits you?

If you can meet a lender’s income and credit requirements, reverse mortgage alternatives like a home equity loan or HELOC will likely be better options. These loans have much lower upfront costs and are easier to understand than reverse mortgages.

Home Equity Loan or HELOC vs. Reverse Mortgage Infographic

Home Equity Loan HELOC Reverse Mortgage
Min. borrower’s age 18 in most states 18 in most states 62
Access to funds Lump sum As required Lump sum, as needed, or monthly
Interest rate Fixed Usually variable but can be fixed Usually variable but can be fixed
Monthly payments required Principal and interest Interest only during the drawing period; principal and interest during the repayment period Any
Min. credit score Mid 600s Mid 600s Any
Own funds required More than 20% More than 20% More than 50%

When to Consider a Home Equity Loan

  • You can meet credit and income requirements
  • You want predictable monthly payments
  • You need a lump sum for a specific purpose
  • You want to bequeath your home to your heirs

When to consider a HELOC

  • You can meet credit and income requirements
  • You want the flexibility to decide when to borrow and how much
  • You want to make interest-only payments for the first few years of the loan
  • You are comfortable with a variable interest rate
  • You want to bequeath your home to your heirs

When to Consider a Reverse Mortgage

  • The equity in your home is your greatest asset.
  • You want to age in place
  • You have bad credit
  • You do not want to make monthly payments
  • You are an elderly retiree
  • You agree with the lender selling your home to pay off the loan once you move out or die

Point: Even if you’re retired, you may still qualify for a second mortgage based on your retirement income from sources such as Social Security, annuities, a pension, or your retirement accounts.

Another option to consider: cash-in refinancing

Older owners might be interested in cash refinancing as an alternative way to leverage home equity.

With a cash-in refinance, you take out a new first mortgage for more than your existing mortgage balance. Proceeds from your new loan pay off your existing mortgage and closing costs. You then keep the rest of the money to use as you wish.

A cash-out refinance can be a good option when prevailing mortgage rates are lower than the rate you’re currently paying, you have good credit, and you’re able to afford the new monthly mortgage payments.

Credible can help you jump-start your cash-out refinance. Checking refinance rates on our platform is simple and only takes a few minutes – and it won’t affect your credit score.

Get the money you need and the rate you deserve

  • Compare lenders
  • Get money to pay off high interest debt
  • Prequalify in just 3 minutes

find my loan
No annoying calls or emails from lenders!

About the Author

Amy Fontinelle

Amy Fontinelle

Amy Fontinelle is an authority on mortgages and credit cards and contributes to Credible. His work has been published in Forbes Advisor, The Motley Fool, Investopedia, International Business Times, MassMutual, etc.

Read more

Leave a Comment