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.
- Home equity line of credit. A "home equity line of credit" (HELOC) is just what it sounds like—a line of credit that's based on the equity you have in the property. HELOCs allow a borrower to draw on a line up to a certain limit approved by the lender.
- Reverse mortgage. A "reverse mortgage" allows older homeowners, typically people who are 62 and older, to draw upon their home equity to receive a lump sum of money, a line of credit, or monthly income. Reverse mortgages, like HELOCs, allow borrowers to convert home equity into cash but have different benefits and risks than HELOCs.
How Home Equity Lines of Credit (HELOCs) Work
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 sound choice if you need additional money for something like home repairs or a major medical bill and can afford monthly payments.
Upsides to Getting a HELOC Instead of a Reverse Mortgage
The upsides to HELOCs include the following.
- They typically have low closing costs and no loan servicing fees.
- There are no age requirements to qualify.
- HELOCs generally have a lower interest rate in comparison to a reverse mortgage loan.
- The house value will almost always 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 Getting a HELOC Instead of a Reverse Mortgage
But HELOCs have downsides, too.
- 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 forecloses, you can lose your home.
- HELOCs don't provide nonrecourse protection in the case of foreclosure. So, the lender can potentially get a deficiency judgment against you after a foreclosure.
How Do Reverse Mortgages Work?
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.
Most Common Type of Reverse Mortgage
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. You must be at least 62 years old to qualify for a HECM.
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 can get 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.
Upsides to Getting a Reverse Mortgage
In addition to not having to make any monthly payments, HECMs are nonrecourse. So, the lender can't come after you (or your estate) for a deficiency judgment after a foreclosure.
Downsides to Getting a Reverse Mortgage
Mortgage brokers and lenders often make it sound like reverse mortgages have no downsides. But this type of loan isn't 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:
- You could run out of money. If you spend down the equity in the property early on, you might run out of money and not be able to cover expenses, like long-term health care costs, taxes, insurance, and upkeep, or be able to finance a move later on.
- You must have enough money to keep up with taxes, maintenance, and other home-related costs. If you don't keep up with the property taxes and homeowners' insurance, as well as maintain the property in reasonable condition, you'll likely face foreclosure and could lose your home. Reverse mortgage lenders have a reputation for foreclosing on older homeowners for relatively minor mortgage violations.
- 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 foreclosure. With a HECM, if you have to move to a nursing home and can't come back to your property 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.
- The costs associated with reverse mortgages are high. Reverse mortgages tend to be expensive due to closing costs, interest, servicing fees, mortgage insurance, and other fees.
- You might not be able to leave anything to heirs. If the home doesn't appreciate significantly, any inheritance your heirs receive will be considerably smaller or nonexistent if you take out a reverse mortgage. And if your heirs want to keep the home, they'll have to satisfy the debt.
- Your Medicaid eligibility could be affected. If you're currently eligible for Medicaid, a reverse mortgage could affect your eligibility.
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.
CPFB Advises Homeowners to Consider All Options
Older homeowners are often coerced into taking out reverse mortgages without realizing that 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:
- opening a HELOC
- refinancing your traditional mortgage to lower the payments
- downsizing to a more affordable home, and
- applying for federal, state, or local programs that provide financial assistance (to pay property taxes or make home repairs, for example) to seniors.
If you're considering a reverse mortgage, it's highly recommended 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 are facing a foreclosure, consider contacting a foreclosure attorney immediately to discuss your options.