Is a reverse mortgage or home equity loan better for me?

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.

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'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.)

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 typically 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 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 forecloses, you can lose your home.
• HELOCs do not provide nonrecourse protection in the case of foreclosure. This means the lender can get a deficiency judgment.

Reverse Mortgages

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. These payments then become the loan, which doesn't have to be repaid until a certain event occurs, like when all of the borrowers have died. Then, the home is typically sold to pay off the loan or deeded to the lender in a process called "deed in lieu of foreclosure." Otherwise, the lender will foreclose to satisfy the debt.

The most common type of reverse mortgage is called a Home Equity Conversion Mortgage (HECM), which is FHA-insured. With this kind of reverse mortgage, 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.)

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 a few advantages to reverse mortgages.

• There are no income or credit requirements to qualify.
• 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. 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.
• 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 elderly 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 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.

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

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:

• 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.

Getting Help

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 such a loan, and watch out for reverse mortgage scams. 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 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.