Deciding whether a reverse mortgage or home equity loan is the better option for accessing your home’s equity can be confusing. Both allow homeowners to tap into their equity without having to move, but they work very differently.
In this comprehensive guide, we’ll explain what reverse mortgages and home equity loans are, how they work, their pros and cons, and help you determine which is the better fit for your unique situation.
What is a Reverse Mortgage?
A reverse mortgage is a special type of loan available to homeowners 62 and older that allows them to convert part of their home’s equity into cash.
With a traditional “forward” mortgage, you make monthly payments to the lender. A reverse mortgage works in reverse – the lender pays you!
You receive funds from the lender in a lump sum fixed monthly payments a line of credit, or a combination. You don’t have to repay the loan as long as you live in the home.
The loan becomes due when you sell the home, move out permanently, or pass away. At that point, you or your heirs can repay the loan and keep the home, or sell the home to settle the debt.
The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM), insured by the FHA.
Pros:
- Access home equity without monthly payments
- Receive funds as a lump sum, monthly payments, or line of credit
- Continue living in your home
Cons:
- High upfront costs
- Interest and fees add up over time, shrinking equity
- Loan must be repaid when you sell, move out, or die
What is a Home Equity Loan?
A home equity loan allows you to borrow against the equity in your home. It works similarly to a traditional “forward” mortgage.
You receive the money upfront in a lump sum payment. Then you repay the loan in fixed monthly installments over a set repayment term, usually 5-30 years.
Home equity loans have fixed interest rates and require you to meet eligibility criteria like income, credit score, and home equity levels. They are also called second mortgages.
Pros:
- Access a lump sum of cash upfront
- Fixed monthly payments and interest rate
- Pay off loan and restore home equity
Cons:
- Monthly payments required
- Risk foreclosure if you default
- Pay closing costs and interest
Key Differences
While reverse mortgages and home equity loans both allow you to tap home equity, they have some important differences:
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Age: Reverse mortgage borrowers must be 62+, while home equity loans have no age requirement.
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Payments: Reverse mortgages have no monthly payments. Home equity loans require fixed monthly payments.
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Interest: Reverse mortgages offer fixed or adjustable rates. Home equity loans have fixed rates.
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Credit/Income: Reverse mortgages have no income or credit requirements. Home equity loans do.
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Fees: Reverse mortgages have high upfront costs, monthly insurance premiums, and interest. Home equity loans have closing costs and interest charges.
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Equity: The equity you borrow gets repaid with a home equity loan. With a reverse mortgage, you use up your equity over time.
When to Consider a Reverse Mortgage
If you need funds but can’t commit to monthly payments, a reverse mortgage allows you to access home equity without repayment as long as you live there. This provides income flexibility.
If you want to age in place, reverse mortgage funds can help cover healthcare, home improvements, and daily expenses so you can stay in your home as you get older.
If you have limited income, a reverse mortgage provides funds without requiring steady employment or pension/retirement income.
If you have a small mortgage balance, you can qualify for a reverse mortgage more easily if you have significant equity already built up.
If you don’t plan to leave the home to heirs, you may opt for a reverse mortgage since the loan would need to be repaid upon transferring the property.
When to Consider a Home Equity Loan
If you need a lump sum for a specific purpose like debt consolidation or a major purchase, the single payout from a home equity loan provides funds upfront.
If you want fixed payments, home equity loan payments remain constant over the loan term, creating reliable budgeting.
If you need funds for home renovations, home equity loan interest can be tax deductible, unlike reverse mortgages.
If you have sufficient income to manage payments, steady employment or retirement income helps qualify and afford a second monthly mortgage bill.
If you want to replenish equity, home equity loans allow you to repay what you borrowed over time and rebuild home equity.
If you plan to leave the home to heirs, you can fully repay a home equity loan and preserve the home’s equity.
8 Key Factors To Compare
Consider these key factors when deciding between a reverse mortgage and home equity loan:
1. Your age – Reverse mortgages require borrowers to be 62+, while home equity loans have no age limit.
2. Your credit and income – Home equity loans require good credit and sufficient income. Reverse mortgages do not.
3. How much equity you need – Compare loan amounts, fees, and equity requirements.
4. How you want to receive proceeds – Lump sum, monthly, or line of credit?
5. Your ability to manage payments – Reverse mortgages have no payments. Home equity loans have fixed monthly payments.
6. Your intended use of funds – Interest may be tax deductible for home improvements with a home equity loan.
7. Long-term plans for the property – Repaying a reverse mortgage requires selling. Home equity loans can be repaid over time.
8. Impact on heirs – Reverse mortgages use up home equity over time. Home equity loans allow equity repayment.
Carefully considering these key factors will help you determine if a reverse mortgage or home equity loan better aligns with your financial situation and goals.
Pros and Cons of Reverse Mortgages vs Home Equity Loans
| Reverse Mortgage | Home Equity Loan | |
|---|---|---|
| Pros | – Access home equity without monthly payments<br>- Receive funds as lump sum, monthly payments, or line of credit<br>- Continue living in your home | – Access lump sum cash upfront<br>- Fixed monthly payments and interest rate<br>- Pay off loan and restore home equity |
| Cons | – High upfront costs<br>- Interest and fees reduce equity over time<br>- Loan must be repaid when you move, sell, or die | – Monthly payments required<br>- Risk foreclosure if you default<br>- Pay closing costs and interest |
The Bottom Line
Reverse mortgages and home equity loans can both provide financial flexibility by allowing you to access your home’s equity. But they vary significantly in how they work.
Reverse mortgages offer funds with no monthly repayment required and allow seniors to age in place. However, upfront costs are high, and interest accrues over time, reducing equity.
Meanwhile, home equity loans provide a lump sum upfront that you repay with fixed monthly payments over time. This restores the equity you borrow. But payments are required, and you risk foreclosure if you default.
Considering your age, income, credit health, planned use of funds and long-term goals can help determine if a reverse mortgage or home equity loan better suits your needs. Consult with a financial advisor for guidance on choosing the right home equity option.
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Home Equity Line of Credit (HELOC)
With a home equity line of credit (HELOC), you have the option to borrow up to an approved credit limit on an as-needed basis. In that regard, a HELOC functions more like a credit card.
With a standard home equity loan, you pay interest on the entire loan amount, but with a HELOC, you pay interest only on the money you actually withdraw.
The fixed interest rate on a home equity loan means you always know what your payment will be, while the variable rate on a HELOC means the payment amount varies.
Currently, the interest you pay on home equity loans and HELOCs is not tax deductible unless you use the money for home renovations or similar activities on the residence that secures the loans. Before the Tax Cuts and Jobs Act of 2017, interest on home equity debt was all or partially tax deductible. Note that this change is for tax years 2018 to 2025.
In addition—and this is an important reason to make this choice—with a home equity loan and a HELOC, your home remains an asset for you and your heirs. It’s important to note, however, that your home acts as collateral, so you risk losing your home to foreclosure if you default on the loan.
Disbursement
- Reverse mortgage: monthly payments, lump-sum payment, line of credit, or some combination of these.
- Home equity loan: lump-sum payment.
- HELOC: as-needed, up to a pre-approved credit limit—comes with a credit card, debit card, or a checkbook.
Reverse Mortgages VS Home Equity Loan
FAQ
What is the difference between a reverse mortgage and a home equity loan?
What is the downside to a reverse mortgage?
What does Suze Orman say about reverse mortgages?
What is the 60% rule for reverse mortgage?
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.
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.
How does a reverse mortgage work?
A reverse mortgage works differently than a forward mortgage —instead of making payments to a lender, the lender makes payments to you based on a percentage of your home’s value. Over time, your debt increases—as payments are made to you and interest accrues—and your equity decreases as the lender purchases more and more of it.
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.