Reverse mortgages and home equity loans both allow homeowners to tap into their home equity. However, there are key differences to be aware of, starting with the fact that reverse mortgages are reserved for homeowners who are at least 62 years of age. There are no age restrictions on home equity loans, though, which could make them an ideal option since they are more accessible to a larger base of homeowners.
This guide explores both types of home equity products, how they work, the similarities and differences between them, and how to know which is the best fit for you.
What is a Reverse Mortgage and How Does It Work?
A reverse mortgage is a type of home loan available exclusively to homeowners aged 62 and older. It allows you to access your home equity without adding to your debt load, as you won’t make monthly mortgage payments to the lender. Instead, the lender will make payments to you monthly, in a lump sum or through a line of credit.
When you take out a reverse mortgage, your outstanding loan balance increases over time as you receive payments. The upside is the balance doesn’t become payable until you sell your home or relocate.
The outstanding mortgage balance is also payable if you pass away. The balance is typically settled by selling your home. If the sale of the home turns a profit, it goes to your heirs.
Types of Reverse Mortgages
There are three primary types of reverse mortgages to be aware of.
FHA-Insured Home Equity Conversion Mortgages (HECMs)
Backed by the Federal Housing Administration, the HECM is the most common type of reverse mortgage product on the market. The amount of home equity you can access through an HECM depends on your age, your home’s value, and current interest rates.
If you’re eligible, you can choose to receive funds through monthly payments, a lump sum payment, a line of credit or a combination of these options. Keep in mind that HECMs often come with higher upfront costs compared to other types of reverse mortgages since they are federally insured.
Proprietary Reverse Mortgages
Proprietary reverse mortgages are not federally insured. Instead, they are offered through private lenders and designed for homeowners with high-value properties with a sizable amount of home equity.
You’ll find more flexibility with these reverse mortgages in terms of loan amounts, interest rates, and fee structures. That said, the lack of federal backing means fewer regulatory protections for the homeowner.
Single-Purpose Reverse Mortgages
Single-purpose reverse mortgages are available through select non-profit organizations and some state and local government agencies. They are designed to meet specific objectives, such as covering property taxes or expensive home repairs.
These mortgage products often come with lower costs than other reverse mortgage options. However, the loan amount is typically smaller, and spending restrictions apply.
What is a Home Equity Loan and How Does It Work?
A home equity loan also lets you convert your home equity into cash. Most lenders let you borrow up to 85% of your home equity. To illustrate, if your mortgage balance is $175,000 and your home is worth $325,000, you could potentially borrow up to $101,250 ($325,000 * .85 minus $175,000) with a home equity loan.
If approved, you’ll receive the loan proceeds in a lump sum. Since the interest rate is fixed, you’ll repay what you borrow in equal monthly installments over a set period.
Keep in mind that it acts as a second mortgage and uses your home as security. So, if you fall behind on the payments, you could lose your home to foreclosure.
Similarities Between Reverse Mortgages vs Home Equity Loans
Reverse mortgages and home equity loans share many similarities.
Use of Home Equity
Both let you pull cash from your home without needing to see it. The amount you can draw is based on your home equity, which is the difference between your property’s market value and what you owe on your mortgage.
Secured Loans
The property is used as collateral to secure both reverse mortgages and home equity loans. In turn, you could qualify for more competitive rates compared to unsecured loans since there is less risk for the lender. However, you also put your home at risk of foreclosure if you fail to adhere to the loan terms.
Application Process
The application process for both products is rather involved, as the lender will review your financial profile and order an appraisal to confirm your property’s market value. Prepare to provide income and asset documentation, along with evidence of homeownership.
What is the Difference Between a Reverse Mortgage and a Home Equity Loan?
A reverse mortgage allows homeowners aged 62 or older to convert part of their home equity into cash. You don’t repay this loan until you sell your home, move out or pass away.
With a home equity loan, you receive a lump sum upfront and repay it in monthly payments over a set term. This loan is available to homeowners of any age who have at least 15% in home equity.
Other Key Differences: Reverse Mortgage vs Home Equity Loan
Before deciding which option is best to access your home equity, it’s best to familiarize yourself with the differences between the two.
Eligibility Requirements
- Reverse mortgage: You must be at least 62 years old and own your phone outright or have a small mortgage balance.
- Home equity loan: There are no age restrictions, but you must have at least 15% in home equity and meet the lender’s credit and income guidelines.
Loan Amount Determination
- Reverse mortgage: It is based on your home’s value, current interest rates and the age of the youngest borrower.
- Home equity loan: This loan is based on the amount of equity in your home and the lender’s loan-to-value (LTV) guidelines.
Loan Disbursement Methods
- Reverse mortgage: Funds can be disbursed as a lump sum, through a line of credit or in monthly payments.
- Home equity loan: Funds are disbursed as a lump sum.
Repayment Terms and Schemes
- Reverse mortgage: The mortgage balance becomes payable if you sell the home, relocate or pass away.
- Home equity loan: The loan is paid in equal monthly installments over a set period – typically five to 30 years.
Interest Rates and Fees
- Reverse mortgage: You can get a fixed or adjustable rate on a reverse mortgage, but they are often higher than what you’ll get with a traditional mortgage.
- Home equity loan: The interest rate is usually fixed on home equity loans.
Impact on Heirs and Estate
- Reverse mortgage: If you pass away, your heirs must sell the property to satisfy the debt or pay off the balance to keep it.
- Home equity loan: If you pass away, the balance becomes your heirs’ responsibility. They can sell the property to cover the remaining debt and keep the home.
Pros and Cons of Reverse Mortgages
Pros
- Access home equity with no monthly payments
- Choose the disbursement method that works best for you
- Heirs won’t ever owe more than the home is worth
- Stay in your home and maintain your standard of living without having to make payments
Cons
- Failure to pay property taxes, homeowners insurance, or maintain the property could result in foreclosure
- Interest accumulates over time, increasing the loan amount
- Age restrictions limit access to this product
- Heirs could receive little or no inheritance from the home if the home is worth less than what’s owed
Ideal Candidates for Reverse Mortgages
A reverse mortgage could be a good fit if:
- You’re at least 62 years old and looking for ways to supplement your retirement income.
- You have a sizable amount of equity in your home and want to tap into it without taking on additional debt.
- You have little or no savings, and your income isn’t enough to cover basic living expenses.
- You want to stay in your home as you age without having to make mortgage payments.
Pros and Cons of Home Equity Loans
Pros
- No age restrictions
- Fixed interest rate gives you predictable monthly payments
- Interest may be tax-deductible if funds are used to make substantial home improvements
- More borrowing power compared to traditional loans for some borrowers
Cons
- A lower credit score could mean a steep interest rate
- Closing costs could be a deterrent
- Monthly payments could strain your budget
- Risk of foreclosure if you default on loan payments
Ideal Candidates for Home Equity Loans
A home equity loan could be more ideal if:
- You have good or excellent credit and can qualify for the most attractive loan terms.
- You have at least 15-20% in home equity.
- You want a lump sum payment to cover a large expense.
- You have a consistent, verifiable income source and can afford the loan payments.
- You plan to stay in your home for the foreseeable future.
- You like the idea of a reverse mortgage but are too young to qualify.
Conclusion: How to Choose the Right Option for You
A reverse mortgage is ideal for older homeowners looking to access cash without monthly payments. At the same time, a home equity loan is better for those who want a lump sum and can manage regular payments or who do not qualify for a reverse mortgage due to age restrictions.
Ultimately, choosing between the two depends on your age, financial situation and goals.
