Reverse mortgage vs. home equity loan

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In a Nutshell

Home equity is collateral for both reverse mortgages and home equity loans. A reverse mortgage allows older adults to borrow a one-time sum or receive regular payments, then pay off the loan by selling their home. A home equity loan gives homeowners of any age an upfront sum of money, which they typically pay off in monthly installments.
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If you’re thinking about accessing your home equity, you might want to take out a reverse mortgage or a home equity loan.

Both reverse mortgages and home equity loans allow you to borrow against the value you own in your home, but they work very differently.

The most common reverse mortgage — a home equity conversion mortgage, or HECM — is available only to homeowners age 62 or older who have paid off their mortgage or have a low remaining balance. You don’t make monthly payments on this type of home loan, but the amount you owe grows over time. You pay it off when you move out of the home or when you die, and that usually means you or your heirs must sell the home once you’re no longer living there.

A home equity loan is available to borrowers of any age, and 20% equity in the home is generally required. You borrow money in a lump sum when you sign the loan, and you pay it back in monthly installments for a set number of years. If you don’t make these payments on time, you can lose your home.

In this article, we’ll discuss the differences between these two borrowing methods and go over when it makes sense to consider each of them. We’ll also review some other financing options that could serve as alternatives.

What is the difference between a reverse mortgage and a home equity loan?

A major difference between a reverse mortgage and a home equity loan is that the balance on a reverse mortgage increases over the course of the loan, and you must pay it off all at once when you leave your home. That generally means your home must be sold when you move out or die.

With a home equity loan, you make monthly payments that gradually reduce your balance until you’ve paid off the loan in full. If you pay it back on schedule, there’s no need to sell your home at the close of the loan term.

Other differences have to do with qualification requirements and how you receive the loan proceeds.

Differences between reverse mortgages and home equity loans
Reverse mortgageHome equity loan
Must be 62 or olderNo age requirement  
Borrow lump sum or annuity-like payment from home equityTypically get loan in a single lump sum payment  
Must own the home or have a small mortgage balanceMust have at least 20% equity
Balance plus interest due upon moving, selling or dying.Repay in regular installments to cover principal and interest

When should you consider a reverse mortgage?

If you’re retired and much of your net worth is the equity in your home, you might consider a reverse mortgage to turn that equity into cash. This option can make sense if you won’t otherwise have enough income to cover your living expenses and if you want to continue living in your home for the foreseeable future.

But you should think carefully before deciding on a reverse mortgage. As time goes on, the amount you owe on a reverse mortgage grows, so it can become difficult to get out of the loan without selling your house.

Because the Federal Housing Administration insures home equity conversion mortgages, you also need to make sure that you can abide by the terms of the loan, such as the requirements that you keep the home well maintained and that you pay your property taxes and homeowners insurance.

In addition to HECM loans, some lenders may offer proprietary reverse mortgages. These loans typically aren’t insured by the FHA. You may also be able to find single-purpose reverse mortgage loans offered by some nonprofits or state and local governments.

If you’re considering a reverse mortgage, be sure to shop around to compare options, terms and fees. Loan costs — which include origination fees, interest rates and closing costs among other things — vary among lenders.

You should also be aware of reverse mortgage scams. If anyone tells you to take out a reverse mortgage to buy an investment or to pay for home repairs they’re selling, it could be a scam.

What are some of the costs?

Reverse mortgages are usually more expensive than other methods of borrowing against your home equity.

Reverse mortgages come with upfront costs. These include origination fees that you owe to the lender. They also include closing costs such as appraisal fees and title search fees.

For reverse mortgages guaranteed by the FHA, you’ll pay an initial mortgage insurance premium. This insurance ensures that you get your expected loan proceeds.

You might be able to roll upfront costs into your loan so that you don’t have to pay them in cash at the loan closing, but you or your heirs will then have to pay them when your home is sold.

Ongoing costs for reverse mortgages include an annual mortgage insurance premium equal to 0.5% of your current loan balance. Remember, your loan balance goes up over the course of a reverse mortgage, so this premium will also increase over the life of the loan.

Other ongoing costs include interest, servicing fees, homeowners insurance premiums and property taxes. In some locations, you may have to pay for flood insurance.

You also have to pay for any repairs needed to keep your home in good shape.

How do you receive the money from your loan proceeds?

There are a few ways you can receive the money from a reverse mortgage.

You can take one lump sum payment when you close on the loan and pay a fixed interest rate on that amount. This is generally more expensive than the other choices, and the total amount you can borrow is often lower. You won’t be able to withdraw more later, so you should make sure that the lump sum will last for the remaining time in your home.

Alternatively, you can get a line of credit. With this option, you’re charged a variable interest rate. If you don’t withdraw all your available funds upfront, your borrowing limit can go up over time. You pay interest and fees only on the money you take out, so this choice can be less expensive than a lump sum payment.

Or, you can choose a monthly payment, which would continue either for a certain number of years or until you’ve borrowed as much as you’re eligible for. This costs less than a lump sum payment, and you may be able to supplement it with a line of credit.

Do you plan to remain in your home for a long time?

A reverse mortgage is more likely to be worthwhile if you expect to stay in your home for many years. If you’re going to move soon, you might want to choose a less expensive way to take money out of your home equity in the short term.

When should you consider a home equity loan?

While a reverse mortgage has very specific limitations on who can qualify, a home equity loan or second mortgage is available to people in a wider variety of situations. You don’t have to be a certain age, and you can have a fairly large outstanding balance on your first mortgage.

A home equity loan may be worth considering if you need to access a certain amount of cash to pay unexpected bills, cover medical expenses or make a big purchase. This type of loan gives you the proceeds upfront, so it makes sense to use it for a one-time purpose rather than for ongoing costs.

Before opting for a home equity loan, you’ll want to consider some of the following criteria.

Do you have enough equity in your home?

Typically, lenders will require you to have at least 20% equity in your home before taking out a home equity loan. And you’re usually capped at borrowing 80% of the equity you’ve built up. So this option makes sense only if you have enough equity available to use.

Can you qualify for a reasonable interest rate?

A home equity loan typically comes with a fixed interest rate, so you’ll pay the same rate for the life of the loan. You’ll want to try to find the best rate possible because even a slightly lower rate can save you a significant amount of money. You should compare annual percentage rates, or APRs, on different loans to find the least expensive one.

Will you be able to afford the monthly payments

Taking out a home equity loan puts your home on the line. If you aren’t able to keep up with your payments, your lender could foreclose on your home. You’d lose your home, and the equity you’ve worked for would be gone. Only consider a home equity loan if you’re confident that you can make the payments each month.

Other financing options

You may want to consider the following alternatives to a reverse mortgage or a home equity loan.

  • A HELOC. A home equity line of credit is a form of revolving credit that uses your home equity as collateral. You can borrow money and pay it back repeatedly as long as you don’t go over your borrowing limit. After the borrowing period, you must repay your remaining balance, either with a lump sum payment or in monthly installments.
  • A cash-out refinance allows you to take out a new mortgage that’s larger than the remaining balance on your existing mortgage. You use the new mortgage to pay off your existing mortgage, and you get the money that’s left over in cash. You then make monthly payments on the entire amount you owe.
  • An unsecured personal loan. You borrow a lump sum upfront, then make fixed monthly payments for a set time. There’s no collateral, so your home is not at risk if you fail to repay the loan. But the interest rate will often be higher than what you’d pay if you borrowed against home equity.

What’s next?

Ask yourself these questions as you review your options.

  • How much equity do I have? You’ll need at least 20% equity for a home equity loan, while you must have paid off almost all of your mortgage to qualify for a reverse mortgage.
  • Do I have enough income to cover monthly payments? If you’re retired and on a fixed income, a reverse mortgage could allow you to borrow without repaying by installments. But if you can fit loan payments into your budget, you might be better off with a home equity loan because it doesn’t require giving up your home in the future.
  • How long do I want to stay in my home? If you aren’t planning on staying in your home for many more years, a reverse mortgage may not be the best choice.
  • Do I need to borrow a large amount of cash all at once, or smaller amounts multiple times? A home equity loan gives you the proceeds in a lump sum. If you need to borrow more frequently, you might prefer a reverse mortgage with disbursement through monthly installments or a line of credit.

About the author: Sarah Brodsky is a freelance writer covering personal finance and economics. She has a bachelor’s degree in economics from The University of Chicago. Sarah has written for companies such as Hcareers, Impactivate and K… Read more.