Homeowners at least 62 years old with substantial equity in their homes may find reverse mortgages appealing. You can convert the equity into cash to meet your needs or financial goals. If you aren’t of age to qualify for a reverse mortgage, a home equity loan or home equity line of credit (HELOC) could be ideal.
But what if none of these options work for you? You could get equity out of your home without incurring additional debt through a shared home equity investing agreement.
Reverse Mortgage vs. Home Equity Loan vs. HELOC: An Overview
Here’s a breakdown of how home equity loans, home equity lines of credit (HELOCs), and reverse mortgages work.
Home Equity Loan
A home equity loan lets you convert your equity into cash. They’re offered by traditional banks, credit unions, and online lenders to homeowners who meet specific criteria. Home equity loans act as a second mortgage, and the interest rate is fixed.
Generally, you’ll need a credit score of 620 or higher, a debt-to-income ratio (DTI) of no more than 43 percent, and at least 15 to 20 percent of equity in your home. Depending on these factors, you could borrow up to 85 percent of your home’s value minus the amount owed on the mortgage.
To illustrate, if your home is worth $335,000 and you owe $245,000 on your mortgage, you could qualify for up to $39,750($335,000 * .85 – $245,000). The lender will assess your finances and credit health to determine your loan amount.
When the loan proceeds are disbursed, you’ll make monthly payments over a set period. But if you fall behind on payments, the lender could foreclose on your home.
Home Equity Line of Credit (HELOC)
HELOCs operate like home equity loans and allow you to tap into your home equity. However, you’ll get access to a pool of funds instead of a lump sum of cash if your application is approved.
You can make withdrawals up to the credit limit during what’s referred to as the draw period. The lender will also require you to make monthly interest-only payments on the amount you borrow during the draw period. But when it ends, you’ll no longer be able to make withdrawals. Monthly payments for both principal and interest on your remaining outstanding balance will also commence, and they could fluctuate since the interest rate on HELOCs is variable.
Reverse Mortgage
A reverse mortgage is a home loan for seniors looking to turn their equity into cash. It’s reserved for individuals 62 years of age, and there are no restrictions on how the loan proceeds can be used.
But unlike traditional home equity products, you won’t continue to make monthly mortgage payments on your home. The lender will make monthly payments to you either at once or in chunks, depending on the payment option you choose.
If you get a fixed-rate reverse mortgage, the lender will disperse the funds in a lump sum.
However, adjustable reverse mortgages offer these options:
- Line of credit: get payments until you reach the borrowing limit
- Modified tenure: access a line of credit and get equal monthly payments for a set period as long as you or your spouse reside in the home)
- Tenure: get equal monthly payments for a set period over time as long as you or your spouse reside in the home
- Modified tenure: access a line of credit and get equal monthly payments for a set period
- Term payments: receive equal monthly payments for a set period
The amount of equity that can be converted into cash depends on your life expectancy. Generally, older homeowners can convert greater sums of equity into cash.
Unfortunately, defaulting on property taxes and homeowners insurance payments could cause you to lose your home. Your property could also be at risk if you fail to make the required maintenance repairs or reside outside the property for the bulk of the year.
You should also know that the lender will take possession of your home when you pass away unless you have a surviving spouse. Otherwise, your heirs must pay the outstanding loan balance in full or 95 percent of the appraised property value.
Differences Between Reverse Mortgages vs. Home Equity Loans and HELOCs
Here’s how reverse mortgages, home equity loans, and HELOC products differ.
Reverse Mortgage vs. Home Equity Loans and HELOCs
You must be 62 years of age or older to qualify for a reverse mortgage, but there are no age restrictions on home equity loans and HELOCs, making it a good option for retired individuals who have paid their mortgages in full or have higher home equity. Same as with a home equity loan, you will get the loan proceeds in one lump sum. The main difference between home equity loans and reverse mortgages is the repayment terms. Home equity loans have to be repaid in monthly payments. Meanwhile, reverse mortgages are paid back when you move, sell your house, or die.
Home Equity Loan vs. HELOC
Home equity loans and HELOCs serve the same purpose, but there are slight differences to be aware of. Most home equity loans offer fixed interest rates, but HELOC rates are generally variable. Also, lenders disburse home equity loans at once, and you only withdraw as much as you need from HELOCs.
How to Choose Between a Reverse Mortgage, Home Equity Loan, or HELOC
Home equity loans and HELOCs are ideal for homeowners who need extra cash to pay off high-interest debt, make home upgrades to boost their home value, or meet other financial goals. But you should only consider this option if you can afford to make timely monthly payments.
Reverse mortgages could be appealing to seniors as the lender pays you, and monthly mortgage payments aren’t required. But there are downsides. The interest rates are typically higher than you’d find when other home equity products. Plus, your equity will decrease as the lender makes payments to you. In turn, your outstanding loan balance will increase and pose serious financial risks if you deplete your equity and run out of cash.
Home Equity Investing: An Alternative Way to Access Equity
If you aren’t of age for a reverse mortgage or don’t qualify for a home equity loan or HELOC, there are some alternative ways to access home equity. You can get equity out of your home through a shared equity agreement.
Consider a reputable investor to lend a helping hand. In exchange for a share in your home’s future profits, they will give you a lump sum of cash today.
