The major differences between home equity loans, home equity lines of credit, and reverse mortgages are the interest rates, how you receive the money, and how you pay it back. Home equity loans, also called second mortgages, offer greater spending flexibility. A home equity line of credit is similar to a credit card, letting you spend only what you need during the draw period, up to the approved limit. A reverse mortgage does not require monthly payments and is only for borrowers who are at least 62 years old. Consider these and other factors when choosing the right option for you.
You may have run across terms such as reverse mortgages, home equity loans, and HELOC. Each of these is different from traditional mortgage loans and provides its own unique advantages. So how do you know if these programs are suited for you and can benefit you? Below, we define all of these, discuss their pros and cons, and explore how to know which, if any, best suits your needs.
An overview of home equity lending and reverse mortgages
All three of these loan products have one thing in common: they allow you to tap into your home equity without having to sell or move out of your home. However, they are very different so we need to get into the weeds to understand which option is best for you.
Home equity loans
If you have a home equity loan, you will receive a lump sum to pay back in monthly payments with a fixed interest rate. The payments are fixed and the interest rates are low, which makes this an inexpensive way to leverage the equity in your home.
Most people who consider a home equity loan already have an existing mortgage. Because of this, they are often referred to as a second mortgage.
Home equity line of credit (HELOC)
A home equity line of credit (also referred to as a HELOC) is similar to a credit card account. Homeowners can borrow money from the equity loan for a period of generally five to 10 years. During this time, you can spend as much as you need up to the credit line amount.
At the end of the five to 10 years, you enter a repayment period and pay back the money you borrowed. The repayment period generally lasts 10 to 20 years. The interest rate for HELOCs is typically not fixed, so the payments will often vary from month to month.
With a reverse mortgage loan, the homeowner receives monthly payments or a lump sum from the lender. The lump sum or monthly payment adds to the borrower’s retirement income (such as Social Security or a pension). Reverse mortgages are usually paid back when the owner sells the home, moves out, or passes away. A reverse mortgage is only available for homeowners who are at least 62 years old. It provides an easy way for older homeowners to tap into their home equity without having to make monthly payments. The balance of a reverse mortgage grows with time, as opposed to the balance of a regular mortgage loan, which diminishes over time.
One type of reverse mortgage is a home equity conversion mortgage (HECM). Home equity conversion mortgages are insured by the federal housing administration. A HECM has many of the same requirements as other reverse mortgages: you must be at least 62 and own your home outright (or at least have substantial equity).
Four factors to consider when comparing your options
One of the main similarities with all three of these loans is that a lender could foreclose your home if you don’t make payments on time. Monthly payments are not a requirement with reverse mortgages, but a foreclosure could happen if you stop living in the home, fail to pay property taxes, or don’t keep up with homeowners insurance.
Here are some more similarities and differences between each of these loans when it comes to interest rates, payments, taxes, and eligibility requirements.
|Home equity loan||HELOC||Reverse Mortgage|
|Interest rates||Fixed interest rate.||Most have a variable interest rate.||Fixed or variable interest rates are available.|
|Payment distribution||Lump-sum and fixed monthly payments.||Use line of credit as needed, monthly payments start after the draw period.||Lump-sum, annuity, or line of credit. No payments until the owner sells the home or dies.|
|Taxes||Interest is tax-deductible if the money was used to buy, build, or improve the home.||Interest is tax-deductible if the money was used to buy, build, or improve the home.||Interest is not deductible.|
|Eligibility requirements||Usually requires a minimum of 20% equity, good credit, and proof of a steady income.||Usually requires a minimum 20% equity, good credit, and proof of a steady income.||Must have a small mortgage balance or own the home outright. No specific income requirements, but lenders may check borrowers can afford the tax, insurance, and maintenance payments.|
Pros and cons of each financing option
Here are lists of the benefits and drawbacks to consider when comparing home equity loans, HELOCs, and reverse mortgages.
- Fixed interest rates
- Borrowing costs are usually lower
- Flexibility with what you can use your loan for
- Interest payments are sometimes tax-deductible
- Rates are usually higher than those for a home equity loan
- Closing costs apply and may cost between 2% and 5% of the loan amount
- You will have two mortgage payments
- Flexibility with spending during the draw period
- Interest might be tax deductible
- Interest rates may rise, leading to higher payments
- This could lead to overspending or tapping out the equity
- You will not have to repay more than what your home is worth
- You can take out a reverse mortgage without having to relocate
- Have to be at least 62 to qualify
- Interest cannot be deducted from taxes until the loan is paid off
Which is best for you?
When deciding which loan is best for you, be sure to consider how the money is distributed, what interest rates are, and how you can spend the money. These are all important factors and can help you decide which loan makes the best sense for you.
|Might be the best option for:|
|Home Equity Loans||borrowers who know exactly how much money they need, value low interest rates, and fixed monthly payments.|
|HELOCs||homeowners who prefer a line of credit over a lump-sum and are OK with variable interest rates (some lenders do offer fixed rates also).|
|Reverse Mortgages||older homeowners (62+) who can’t qualify for lower-cost options, and want to avoid making payments until they sell the home.|
A home equity loan allows a lot of flexibility with what you can spend the money on. Because of this, a home equity loan could be best for those who need a set amount of money and not an open-ended line of credit. Home equity loans can be used to make major purchases such as a home renovation, pay medical bills, or cover emergency expenses.
A HELOC is great for those who can afford the monthly payments and don’t mind the uncertainty of variable rates. It’s also best for those who aren’t exactly sure how much money they’ll need to borrow and enjoy the flexibility of withdrawing only what they require.
If you are at least 62 and don’t qualify for a HELOC, a reverse mortgage is worth looking into. A reverse mortgage loan is also great for those who want to access equity, don’t want monthly payments, and already own their home (or at least have some equity on it). You can also look into a home equity conversion mortgage, which is a type of reverse mortgage.
Frequently asked questions
What can you do if you don’t qualify for a reverse mortgage?
Shared equity mortgages can be a good alternative for homeowners who want a “debt-free” option. Traditional home equity financing, such as HELOCs, home equity loans, cash-out mortgage refinancing may have a lower total cost if you can afford the monthly payments and meet the eligibility requirements. The best financing option for you will depend on your personal financial situation and what you want to do with the loan.
Can you have a HELOC and a reverse mortgage?
No. You can get a HELOC or a reverse mortgage, but you cannot have both. However, you can get a new reverse mortgage to refinance your existing one or pay it off and then get a HELOC.
Is a reverse mortgage like a second mortgage?
A reverse mortgage is not a second mortgage. A home equity loan is often referred to as a second mortgage. Reverse mortgages are not.
What is the downside to a reverse mortgage?
- A home equity loan gives the borrower a lump-sum payment, which is paid back through fixed monthly payments.
- Home equity loans are often referred to as second mortgages.
- A HELOC is similar to credit cards. You can spend as much as you need up to the line of credit.
- Reverse mortgages are only for those who are 62 and older. The balance grows over time, and monthly payments are not required.
Camilla has a background in journalism and business communications. She specializes in writing complex information in understandable ways. She has written on a variety of topics including money, science, personal finance, politics, and more. Her work has been published in the HuffPost, KSL.com, Deseret News, and more.