Once you reach 62 years old and are considering accessing the equity in your home, an additional opportunity in the form of a reverse mortgage becomes available. You could always leverage your home equity in the form of a home equity line of credit or HELOC, but with this additional option, which is right for you? Both are more flexible than other loans and have inherent risks that you need to consider before deciding which one works best for you.
Difference between a HELOC and a Reverse Mortgage
Image via Flickr by aag_photos Licensed CC BY-SA 2.0
A reverse mortgage is only available for homeowners 62 or older and allows an entirely different mechanism. Instead of making payments on your mortgage slowly paying down the principal, a reverse mortgage pays you a monthly payment, growing your mortgage’s balance rather than paying it down.
A HELOC, on the other hand, works more like a credit card that utilizes the equity in your home as collateral. You’re granted a credit line in an amount that would equal about 80% to 85% of your home’s market value when added to your current mortgage. For example, if you own a $200,000 home, your total loan amount, using 80%, would be $160,000. If your current mortgage balance due is $100,000, you would have $60,000 available in the form of a HELOC. There is a period, typically 10 years, where you can draw from that line of credit.
The only payment required during the draw period is the interest on whatever you have drawn against the HELOC. You can pay more for the principal down and reuse it as many times as you would like. After the draw period, you enter the repayment period. Now, your HELOC becomes like a standard loan, and you can no longer draw against it. You must make a set monthly payment covering interest and principal so that it’s paid off in a specific time, usually 10 to 20 years.
So what are some more of the differences between a reverse mortgage and a HELOC? Let’s discuss a few more below.
Monthly Payment
There’s no monthly payment with a reverse mortgage, and you receive a payment every month. A HELOC requires interest-only payments during the draw period and then a standard monthly fee for the next 10 to 20 years, in which you will pay off all remaining principal and interest.
Options to Utilize Equity
If you opt for the reverse mortgage option, you can get a fixed monthly payment, a lump sum payment, a line of credit to use when heeded, or a combination of both monthly payment and line of credit. Whereas with a HELOC, you use it just like a credit card, and you can get disbursements as needed.
Closing Costs
A reverse mortgage has closing costs, much as you expect for a traditional mortgage. There can be up to $6,000 in fees in addition to mortgage insurance and upfront closing costs. Conversely, a HELOC usually has fees consisting of about 2% to 5% of the line of credit amount.
Occupancy Requirement
To qualify for a reverse mortgage, the home you use as collateral must be your primary residence for most of the year, while you can take out a HELOC against any property you own.
Mortgage Insurance
A HELOC requires no mortgage insurance (PMI), but a reverse mortgage requires 2% of the value of your home upfront and then 0.5% annual PMI going forward.
Credit Requirements
A HELOC has a minimum credit score requirement, usually around 620, and allows a debt-to-income ratio of no more than 50%. A reverse mortgage has no credit score requirements or debt-to-income restrictions, only proof you can pay your expenses in the future.
Current Equity
To qualify for a reverse mortgage, you must have at least 50% equity in your home, while the HELOC will allow you to have a total loan amount of 85% against your home. Once you get more than 15% equity, you can qualify for a HELOC.
Deciding Between a Reverse Mortgage and HELOC
There are certain scenarios in which a reverse mortgage makes the most sense and others in which a HELOC is the better option. Here are some of the benefits of a reverse mortgage over a HELOC:
- You don’t have a monthly payment.
- You can also get a reverse mortgage as a line of credit like a HELOC, or you can receive regular monthly payments, a lump sum, or even a combination.
- You don’t have to qualify based on income, only your ability to pay your current expenses.
Some of the downsides of a reverse mortgage as compared to a HELOC include:
- If you are under 62 years old, a reverse mortgage isn’t an option for you.
- Every month you use the line of credit in your reverse mortgage or receive a sum of money, the amount of equity in your home goes down.
- A reverse mortgage has significantly higher closing costs and can require mortgage insurance that a HELOC will not.
- If you’re currently receiving fixed-income benefits like Medicaid or Supplemental Security Income, then your payments might be reduced if you get payments from a reverse mortgage.
- Upon your passing, the home is sold to pay off your reverse mortgage and traditional mortgage, thereby reducing money or even the property itself passing to your heirs.
Final Thoughts
You want to remember that both the HELOC and a reverse mortgage are secured with your home as collateral. Defaulting on either of these can lead to home foreclosure by the lender. Even in the case of a reverse mortgage, the lender can still foreclose if you stop using your home as your primary residence or become unable to pay your expenses like insurance and property taxes. A reverse mortgage or a HELOC can be a great way to tap into your home’s equity for some funds you may need for expenses, renovations, or some other need. Understanding the difference between the two can help you decide which one is the better fit for your financial situation.
If you’re looking for loan options, contact the knowledgeable team at Titan Funding. We may have an option to fit your needs. You can reach us at 855-929-1134 or via our secure online messaging system. We’d be happy to talk about lending options available to you.
