If you own your home and want to tap into your equity to get cash, you might be considering two options: taking out a home equity line of credit (HELOC) or getting a reverse mortgage.
Below you can learn more about home equity lines of credit and reverse mortgages, along with the upsides and downsides to these two types of loans.
A home equity line of credit (HELOC) is just what it sounds like—a line of credit loan that's 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 Home Equity Loan and HELOC Basics.)
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.
There are downsides to a HELOC as well.
Reverse mortgages, like HELOCs, allow borrowers to convert home equity into cash, but have different benefits and risks than HELOCs. Before getting a reverse mortgage, you should understand how they work and learn the significant risks associated with them. You also need to watch out for reverse mortgage scams.
The most common type of reverse mortgage is called a Home Equity Conversion Mortgage (HECM), which is FHA-insured. (This insurance protects the lender, not the borrower.) With a HECM, the payments are distributed in the form of a lump sum, monthly amounts, or a line of credit, or a combination of monthly payments and a line of credit. The amount you receive is based on the equity in your home. Because you receive payments from the lender, your equity decreases over time as the loan balance gets larger. (Read about the restrictions and requirements associated with a HECM reverse mortgage.)
In addition to not having to make any monthly payments, there are a few advantages 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. Reverse mortgages are complicated—and risky. For most people, taking out a reverse mortgage is a bad idea.
A few of the substantial issues and risks involved with reverse mortgages include:
Reverse mortgages are structured so that the lender will most likely end up getting the home, either through foreclosure or a deed in lieu. Even if you comply with all of the mortgage terms, you probably won’t have money or equity left when the loan comes due and you’ll likely have to give up the home.
Senior citizen homeowners are often coerced into taking out reverse mortgages without realizing that there are other options are available. The Consumer Protection Financial Bureau (CFPB) advises consumers who are considering taking out a reverse mortgage to consider all other alternatives, including:
If you're considering a reverse mortgage, it's highly recommend that you proceed cautiously and make sure you understand all of the risks and conditions involved with this kind of loan. For more information on reverse mortgages and the risks related thereto, visit AARP’s reverse mortgage webpage. You can also go to the Federal Trade Commission’s website on reverse mortgages.
To learn more about HECMs (reverse mortgages insured by the U.S. Government through the Federal Housing Administration), go to www.hud.gov and enter "Home Equity Conversion Mortgage" in the search box to find a list of relevant links.
An attorney, like a consumer protection attorney, can also help you go over the pros and cons of getting a reverse mortgage. If you already have a reverse mortgage and you're facing a foreclosure, consider contacting an attorney immediately to talk about your options.