If you own your home and want to tap into your equity to get cash, you might consider one of two options: taking out a home equity line of credit (HELOC) or getting a reverse mortgage. But which option is better for you?
Below you can learn more about home equity lines of credit and reverse mortgages, the upsides and downsides to these two types of loans, and then determine if either might work for you.
Home Equity Lines of Credit (HELOCs)
A home equity line of credit (HELOC) is just what it sounds like -- a line of credit loan that is based on the equity of the home. HELOCs allow a borrower to draw on a line up to a certain limit approved by the lender. (Learn more in Nolo’s article Home Equity Loan and HELOC Basics.)
Upsides to HELOCs
A HELOC can be a good option for people looking to leverage their home to get some extra cash and who have enough income to make payments. For example, a HELOC can be a good option if you need additional money for something like home repairs or a major medical bill and can afford monthly payments.
The upsides to HELOCs include the following.
- They have low closing costs and no loan servicing fees.
- There are no age requirements to qualify.
- They generally have a lower interest rate in comparison to a reverse mortgage loan.
- The house value will almost always well exceed the loan balance (which means if you sell the home or leave it to your children, there will still be equity in the property at that time).
Downsides to HELOCs
There are downsides to a HELOC as well.
- You must have excellent or good credit and have a low debt to income ratio to qualify for a HELOC.
- You must make monthly payments to repay the home equity loan. If you don’t make the payments and the lender foreclosures, you will lose your home.
- HELOCs do not provide nonrecourse protection in the case of foreclosure. (This means the lender can get a deficiency judgment. Learn more about deficiency judgments in Nolo’s article Deficiency Judgments: Will You Still Owe Money After the Foreclosure?)
Reverse mortgages, like HELOCs, allow borrowers to convert home equity into cash, but have different benefits and risks than HELOCs.
How Reverse Mortgages Work
A reverse mortgage is different from “forward” mortgages because with a reverse mortgage, the bank pays you, rather than you making payments to the bank. Reverse mortgage payments are distributed in the form of a lump sum, monthly amounts, or a line of credit (or a combination of these options). The amount you receive is based on the equity in your home. Since you receive payments from the lender, your equity decreases over time as the loan balance gets larger.
The loan doesn’t have to be paid back until you die, move, or sell the home. When one of these events occurs, the home is typically sold to pay off the loan or the lender will foreclose to satisfy the debt. (Learn more about reverse mortgages in Nolo’s article Reverse Mortgages for Retirees and Seniors.)
Eligibility for a Reverse Mortgage
Generally, reverse mortgages are available to those who:
- are at least 62 years old
- occupy the home as a principal residence, and
- have substantial equity in the property or own the home outright.
Upsides to Reverse Mortgages
In addition to not having to make any monthly payments, there are other advantages to reverse mortgages.
- There are no income or credit requirements to qualify. (This means that if you cannot qualify for a home equity loan because of low income or credit issues or cannot afford monthly payments, a reverse mortgage might make sense for you.)
- The income is tax-free.
- Reverse mortgages are nonrecourse. The lender can’t come after you (or your estate) for a deficiency judgment after a foreclosure.
Downsides to Reverse Mortgages
Mortgage brokers and lenders often make it sound like there is no downside to a reverse mortgage, but this type of loan is not right for everybody. There are substantial issues and risks involved with reverse mortgages.
- You could run out of money. If you spend down the equity in the property early on, you may run out of money and not be able to cover expenses, such as long-term health care costs, taxes, insurance, and upkeep, or be able to finance a move later on.
- If you don’t keep up with the property taxes and homeowners insurance, as well as maintain the property in reasonable condition, you could face foreclosure. (Learn more in Nolo’s article Foreclosure of Reverse Mortgages.)
- Reverse mortgages are complicated. (Be sure you read the fine print if you take out this type of loan.)
- You could become ill and have to leave the home after taking out the reverse mortgage, which could lead to a foreclosure. (If you have to move to a nursing home and cannot come back to your home for 12 months or more, the lender can call the loan due. Then, in all likelihood, the home will have to be sold in order to pay back the reverse mortgage loan or the lender will foreclose.)
- Reverse mortgages tend to be expensive due to closing costs, interest, servicing fees, mortgage insurance, and other fees.
- If the home doesn’t appreciate significantly, any inheritance your heirs receive will be considerably smaller if you take out a reverse mortgage.
- If you’re currently eligible for Medicaid, a reverse mortgage could affect your eligibility since you cannot have more than a certain amount of money in your checking account on a monthly basis.
CFPB Advises Homeowners to Consider All Options
Senior citizen homeowners are often coerced into taking out reverse mortgages without realizing that there are other options are available. The Consumer Financial Protection Bureau (CFPB) (www.consumerfinance.gov) advises consumers who are considering taking out a reverse mortgage to consider all other alternatives, including:
- opening a HELOC
- refinancing your traditional mortgage to lower the payments
- downsizing to a more affordable home, and/or
- applying for federal, state, or local programs that provide financial assistance (to pay property taxes or make home repairs, for example) to seniors.
Learn more about reverse mortgages, as well as other available options for older homeowners, at AARP’s website at www.aarp.org/revmort.