Home Equity Loan or Reverse Mortgage: Which Is Right for You?
Home equity loans and reverse mortgages work very differently, but in the end accomplish the same thing -- converting older borrowers' home equity that can't be spent into cash that can. Home equity loans allow you to take a lump sum or a line of credit, and so do reverse mortgages. The main differences between the two are that you need good credit and sufficient regular income to qualify for a home equity loan, while there is no income or credit qualification for a reverse mortgage, and one requires payments while the other does not. Finally, home equity loans cost a lot less than most reverse mortgages. Let's examine a few situations to determine if a home equity loan or a reverse mortgage is right for you. Remember, you must be 62 years old, or approaching that age, to consider a reverse mortgage.
Situation: You are financially comfortable, but would like some extra cash in case of an emergency. You may have regular income from investments, Social Security and/or pensions, but would like access to cash if something expensive comes up.
Solution: Home equity line of credit (HELOC). As long as you have decent credit and sufficient income to qualify, a HELOC is a good choice. The cost to set one up is minimal, and you pay no interest unless you actually use the money.
Situation: You are strapped for cash, and need money to pay for property taxes and/or home maintenance. For some seniors, just maintaining a home is a real challenge. Property taxes have increased, the house needs work and the money just isn't there.
Solution: Single-purpose reverse mortgage. These loans are offered by state and local government agencies and nonprofit organizations. They cost little or nothing to set up, and the mortgage rate is very low. Single-purpose reverse mortgages can only be used for property maintenance or to pay taxes, and are for low- to moderate-income seniors.
Situation: You are on a limited fixed income and need more money. You come up short at the end of every month, and you'd like more financial security or a more comfortable lifestyle.
Solution: Home Equity Conversion Mortgage (HECM). While this isn't the cheapest form of financing available, if you don't have money to pay your bills, it may be the only financing available to you. You don't even need good credit to qualify for this reverse mortgage, and you can take monthly payments for a specific time period -- 10 years, for example -- or you may opt for smaller payments for a longer period. Older HECM borrowers can get higher monthly payments than younger borrowers.
Situation: You want to make some home improvements. You need to make your home more comfortable or accessible -- maybe you're no longer able to climb up and down three flights of stairs, or you'd like a new porch.
Solution: Home equity loan (HEL). Unless you need a huge sum, a reverse mortgage is a very expensive way to finance a home improvement. That's because many reverse mortgage fees are based on your home's value, not the loan amount. So, while $6,000 in fees to finance $200,000 in repairs is only 3%, that same $6,000 to finance a $20,000 repair amounts to 30%. Don't have a lot of home equity? Look into an FHA Title 1 loan, which allows you to finance home improvements, and requires little or no equity.
Situation: Your mortgage lender is about to foreclose on your home. You have made your mortgage payments for many years, but now your retirement funds have dried up, your credit has taken a beating and you could lose your home.
Solution: Home Equity Conversion Mortgage (HECM). If you have enough equity, the HECM could pay off your mortgage so you no longer need to worry about foreclosure. You may even be able to get some extra cash, and you won't have to worry about monthly payments.
Situation: The stock market has been hard on your retirement accounts. You need to replace the money. If you keep a large portion of your investments in equities, your retirement fund may be seriously depleted. Furthermore, if you had to use up your assets when stock prices were low, that will cut your chances of participating in the eventual recovery of the market.
Solution: An HECM or home equity loan with a lump-sum distribution. Taking a reverse mortgage or home equity loan and dumping the proceeds into your retirement account may allow you to recover your losses. The difference in the loans is that you have to qualify, income and credit-wise, for the home equity loan, whereas you don't for an HECM. If you can qualify for the home equity loan, it's probably cheaper.
This guide is not a substitute for reverse mortgage counseling. Additional factors, such as your health, will influence your decision to take on a reverse mortgage or home equity loan, and a counselor will help you address these concerns.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.