Reverse Mortgage vs Home Equity Loan: Which Is Better for You?

Reverse mortgages and home equity loans allow homeowners to access the equity in their home, but they work very differently. If you’re considering tapping into your home equity, it’s important to understand the key differences between these two options to choose the best fit for your needs and financial situation.

Overview of Reverse Mortgages and Home Equity Loans

A reverse mortgage is a special type of loan available to homeowners 62 and older. With a reverse mortgage, you receive payments from the lender based on a percentage of your home’s value and the equity you’ve built up. The loan doesn’t need to be repaid until you move sell the home, or pass away.

With a home equity loan, you receive a lump sum payment upfront based on your home equity. You make fixed monthly payments, like a traditional mortgage, to repay the loan over a set repayment term.

Here’s a quick comparison of some key features:

Eligibility Reverse mortgages require borrowers to be 62 or older. Home equity loans have no age requirements
Payments: Reverse mortgages have no monthly payments. Home equity loans require fixed monthly payments.
Interest: Reverse mortgages offer fixed or adjustable rates. Home equity loans have fixed interest rates.
Repayment Reverse mortgages become due when you move, sell, or pass away. Home equity loans have set repayment terms.
Risks: You or heirs may end up owing more than the home’s value with a reverse mortgage. Failure to repay a home equity loan could result in foreclosure.

How Much Money Can You Get?

With both loans, the amount you can borrow depends on how much equity you have in your home.

For a reverse mortgage, several other factors determine your loan amount, including your age, current interest rates, and the lender’s maximum claim amount. Generally, the older you are, the more money you can access through a reverse mortgage.

The amount you can borrow with a home equity loan is based on your equity and your lender’s policies. Many lenders allow you to borrow up to 85% of your equity.

Uses for the Money

A major difference between these two home loans is that reverse mortgages have no restrictions on how you can use the funds. The proceeds from a home equity loan, however, must be used for the purpose stated in the loan application, such as home improvements.

With a reverse mortgage line of credit, you can draw on the funds as needed. A home equity loan provides the full loan amount upfront in a lump sum.

Loan Costs

Both types of loans come with fees and closing costs. Reverse mortgages have generally higher upfront costs, including an initial mortgage insurance premium and appraisal fees. Expect to pay 2% to 5% of the loan amount for a home equity loan.

Ongoing costs also differ. Reverse mortgages have ongoing mortgage insurance premiums, servicing fees, and interest charges. Home equity loans just have monthly principal and interest payments.

Impact on Home Ownership

With a reverse mortgage, you retain ownership of your home. The loan must be repaid when you move out, sell, or die, but you cannot be forced to leave the home as long as you meet the loan obligations.

You also keep ownership of your home with a home equity loan, provided you make the payments. Failure to repay a home equity loan could result in foreclosure.

Effect on Home Equity

A major downside of reverse mortgages is that the loan balance grows over time while your equity shrinks. This happens as loan interest and fees accrue and reduce the amount left for you or your heirs.

With a home equity loan, you pay down the principal and restore your equity over the loan term. This allows you to rebuild home equity for inheritance purposes if desired.

Tax Implications

For reverse mortgages, the loan proceeds are not taxable, and interest is not deductible. With home equity loans, you may qualify for tax deductions if you use the funds for home improvements or other tax-deductible purposes.

Eligibility Requirements

To qualify for a reverse mortgage, you must:

Be 62 years or older
Own your home or have a low mortgage balance
Live in the home as your primary residence

Home equity loans have these typical requirements:

Meet your lender’s age, income, and employment requirements
Have 20% to 30% equity in the home
Have a good credit score, often 620 or higher

When a Reverse Mortgage Is the Better Option

A reverse mortgage may be right for you if:

You need a steady income stream in retirement
You want to access home equity without monthly payments
You are concerned about outliving your savings
You don’t plan to leave the home to heirs
You are looking for a way to age in place

When a Home Equity Loan Is the Better Choice

Consider a home equity loan if:

You are under age 62
You have a short-term need for a lump sum of cash
You want to replenish your home equity over time
You can qualify for the loan and handle the monthly payments
You plan to use the funds for home improvements

The Bottom Line

Reverse mortgages and home equity loans offer two different ways to tap home equity. Reverse mortgages provide tax-free income with no monthly payments, while home equity loans give you a lump sum for other uses. Compare costs, risks, and eligibility to decide if a reverse mortgage or home equity loan better suits your financial situation.

Key Differences Between Reverse Mortgages, Home Equity Loans, and HELOCs

Reverse mortgages, home equity loans, and HELOCs all allow you to convert your home equity into cash. However, they vary in terms of disbursement and repayment, as well as requirements, such as age, equity, credit, and income. Based on these factors, here are the key differences among the three types of loans.

Factors to Consider

Reverse mortgages, home equity loans, and HELOCs all allow you to convert your home equity into cash. So how to decide which loan type is right for you?

In general, a reverse mortgage is considered a better choice if you are looking for a long-term income source and don’t mind that your home will not be part of your estate. However, if you are married, be sure that the rights of the surviving spouse are clear.

Either a home equity loan or a HELOC is considered a better option if you need short-term cash, will be able to make monthly repayments, and prefer to keep your home for your heirs. Both have considerable risks along with their benefits, so review the options thoroughly before taking either action.

Reverse Mortgages VS Home Equity Loan

FAQ

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

Repayment. Repayment for a home equity loan is like your original mortgage: you borrow the money and start repaying the loan through monthly payments. On the opposite end, reverse mortgage balances aren’t due unless the borrower dies, moves or sells the house.

What’s the downside of a reverse mortgage?

A reverse mortgage isn’t free money: The borrowing costs can be high, and you’ll still need to pay for homeowners insurance and property taxes. Reverse mortgages can also complicate life for your heirs, especially if they don’t want the home or the home’s value isn’t enough to cover what’s owed.

What is the 60% rule for reverse mortgage?

Additionally, the program limits the amount of equity accessible within the first 12 months of your loan closing. Called the initial principal limit, you can only withdraw 60 percent of your available equity during the first 12 months, with the remaining equity becoming available after the first 12 months.

What does Suze Orman say about reverse mortgages?

Taking a loan too early The earliest a homeowner is eligible to take out a reverse mortgage is age 62, but Orman considers it risky to do so. “If you tap all your home equity through a reverse at 62 and then at 72 you realize you can’t really afford the home, you will have to sell the home,” she said.

Can a home equity loan be a reverse mortgage?

This option is a reverse mortgage; however, homeowners have other options, including home equity loans and home equity lines of credit (HELOCs). All three allow you to tap into your home equity without the need to sell or move out of your home.

What are reverse mortgages & HELOCs and home equity loans?

Reverse mortgages, HELOCs and home equity loans are three options for accessing your home equity and putting it to work for you. Reverse mortgages are specifically aimed at homeowners aged 62 and older who are looking to access their equity without having a mortgage payment.

What is a reverse mortgage?

Reverse mortgages are a unique type of home equity product available to homeowners ages 62 or older who own their home outright or have a fairly low mortgage balance. Instead of making payments to a lender as with a traditional mortgage, reverse mortgage borrowers receive payouts based on the equity in the home.

How much equity do you need for a reverse mortgage?

You should be close to 100% equity if you want a reverse mortgage. Conversely, most lenders only require you to maintain 20% home equity after factoring in a home equity loan. In our research, we found the interest rate on a reverse mortgage to be lower than on a home equity loan.

What are the different types of reverse mortgages?

The most common type of reverse mortgage is the home equity conversion mortgage (HECM), insured by the federal government. Other reverse mortgage types include single-purpose reverse mortgages — smaller loans for home improvement or other specified uses — and proprietary reverse mortgages — loans financed by private lenders.

When is a reverse mortgage due?

Reverse mortgage (deferred repayment) loans are due as soon as the borrower becomes delinquent on property taxes or insurance, keeps the home in disrepair, dies, or moves out of the home. Home equity loans involve monthly payments made over a set amount of time with a fixed interest rate.