Home Equity Loans vs Reverse Mortgages: Which Is Better for You?

With home prices surging in recent years many homeowners have seen their home equity increase significantly. If you’re looking to tap into your home’s equity, you have a couple options – a home equity loan or a reverse mortgage. But which one is right for you? Here’s a detailed comparison of home equity loans vs reverse mortgages to help you decide.

What is a Home Equity Loan?

A home equity loan is a type of second mortgage that allows you to borrow against the equity in your home. It works similarly to a regular mortgage – you receive the loan in a lump sum payment upfront then make monthly payments over a set repayment term to pay it back.

The amount you can borrow depends on how much equity you have, but lenders typically limit it to 80-85% loan-to-value. So if your home is worth $500,000 and you owe $200,000 on your existing mortgage, your equity is $300,000. With an 85% LTV, you could qualify for around a $255,000 home equity loan.

Home equity loans have fixed interest rates and repayment terms generally ranging from 5-30 years, The benefits include

• Access to lump sum cash quickly
• Lower interest rates than credit cards and personal loans
• Interest may be tax deductible (conditions apply)

The downsides are that you put your home at risk if you default, and monthly payments are required.

What is a Reverse Mortgage?

A reverse mortgage allows homeowners aged 62+ to tap into their home’s equity without having to make monthly repayments. Instead of you making payments to the lender, the lender makes payments to you.

The amount you can borrow depends on your age, home value, current interest rates, and the type of reverse mortgage product you choose. Generally you can access up to 60% of your home’s value.

Unlike a traditional mortgage, the balance on a reverse mortgage grows over time as interest and fees are added. The loan must be repaid when you pass away, sell the home, or move out permanently. At that point, you or your heirs can either repay the loan and keep the home, or sell the home to cover the loan.

Pros of a reverse mortgage include:

• No monthly mortgage payments required
• Income options like lump sum, monthly cash flow, or line of credit
• You retain ownership of the home

Cons are high upfront costs, shrinking equity over time, and less equity left to heirs.

Key Differences Between Home Equity Loans and Reverse Mortgages

Here’s a quick overview of how these two products differ:

As you can see, while both allow you to access home equity, the specifics around repayment, costs, eligibility, and more are quite different.

Deciding Between a Home Equity Loan and Reverse Mortgage

So which one should you choose? Here are some key factors to consider:

Your age

Reverse mortgages have a minimum age requirement of 62. So if you’re younger, a home equity loan is your only option.

Monthly payments

A major appeal of a reverse mortgage is not having monthly payments. If you want to eliminate payments, this can be a great benefit. Home equity loans require set monthly payments.

Loan term needs

Home equity loans have set repayment terms like 5, 10, 15 or 30 years. So they work well if you need a larger sum for a short period. Reverse mortgages are designed to provide funds over your lifetime and don’t have a fixed repayment term.

Upfront costs

Closing costs for a home equity loan range from 2-5% of the loan amount. Reverse mortgages have higher upfront costs, including lender origination fees, mortgage insurance premiums, appraisal fees and more. Total costs can range from $2,000-$6,000 or more.

Credit qualifications

Reverse mortgages have no income or credit requirements. So if you have limited income or poor credit, a reverse mortgage may be your better option. Home equity loans have credit score and debt-to-income requirements that borrowers must meet.

Impact on home equity

With a home equity loan, once it’s repaid your equity is restored. With a reverse mortgage, your equity is reduced over time as the loan balance grows. So consider the impact on the equity you want to leave heirs.

Tax benefits

Home equity loan interest is tax deductible in some cases if funds are used for home improvement. Reverse mortgage interest is not tax deductible.

Loan amount needed

Reverse mortgages allow you to access a lump sum, line of credit, or monthly payments. Home equity loans provide a lump sum upfront. So consider which structure better suits your needs.

Alternatives to Tap Home Equity

Beyond home equity loans and reverse mortgages, a couple other options for accessing home equity include:

• Home Equity Line of Credit (HELOC) – A revolving line of credit with flexible draw periods, variable rates, and interest-only payments.

• Cash-Out Refinance – Refinancing your mortgage for a higher amount to take cash out. Adds to monthly payments.

• Downsizing – Selling your current home to downsize to a less expensive house. Allows you to pocket the equity difference.

Making the Best Choice

As you can see, home equity loans and reverse mortgages each have their own pros and cons. To make the best choice:

• Consider your age, credit profile, and income qualifications
• Review loan amount needed, costs, and repayment terms
• See if you qualify for better loan rates by comparing multiple lenders
• Consult with a loan officer or financial advisor

The right product will depend on your specific situation. But taking the time to understand these two options will help you make an informed decision and get the maximum benefit from your home equity.

Frequency of Entities:

home equity loan: 26
reverse mortgage: 24
HELOC: 2
cash-out refinance: 1
downsizing: 1