Reverse Mortgage vs. Home Equity Loan vs. HELOC: Which is Best?

There are multiple ways to access your home equity without having to actually sell the property. Reverse mortgage, home equity loans, and home equity lines of credit (HELOC) are three unique options that are suitable in different situations. This guide will help you understand which option might be best for you.

Accessing Equity: Cashing In On the Value You've Built

One of the major benefits of homeownership is that your monthly payment goes toward ownership, or equity, in your property. That equity translates to the percentage of your home's resale value you'll receive if you sell. But that equity isn't just about receiving a nice return on your investment when you sell your home. You can leverage your equity even if you don't plan to sell anytime soon. There are several ways to cash in on the equity you've built up in your home. These mostly come in the form of loan products that can provide funds for everything from retirement to vacations, home renovations, or even discretionary spending. But before you get too excited, it's vital to understand that each of these options, including the three we'll highlight in this article, comes with its own rules, requirements, and limitations. These loan products also aren't available to all homeowners. You need to hold substantial equity--at least 20%--before you can qualify for a HELOC or home equity loan, meaning new homeowners typically can't immediately start borrowing against the value of their homes. Some of the qualification requirements are more specific, including age and what you intend to do with the money you receive. This all means that it's essential to choose carefully when you decide which product you use to leverage the equity in your home.

Reverse Mortgage vs. HELOC vs. Home Equity Loan: Requirements and Specifics

Let's review the differences between reverse mortgages, home equity lines of credit (HELOC), and home equity loans. This will help you understand which of these three popular options, if any, are right for you.

Reverse Mortgage

Requirements

• Applicants must be age 62+
• The home in question must be your primary residence
• Your home must be either paid off or nearly there--requirements for how much equity you hold may vary
• The property needs to be in good repair and have retained its value

Specifics With a reverse mortgage, you take out a loan using the value of your home as equity. A reverse mortgage is an alternative to selling your home--it's a way of allowing seniors to stay put in the homes they love and also access the value of the properties they own while they're alive. Reverse home loans don't require monthly payments. Instead of regular monthly payments, the balance of the loan comes due when the homeowner vacates the property, whether due to selling the home, dying, or obtaining a new primary residence. You can use the funds from a reverse mortgage as you see fit. Most people use these loans to finance their retirement, though it's best to have other sources of funds on hand in addition to those obtained through a reverse mortgage.

Home Equity Loan

Requirements

• A good credit score--the higher, the better your chances are of qualifying for a home equity loan with favorable terms
• Positive payment history on credit accounts including your mortgage (i.e., no recent missed payments)
• A favorable debt-to-income ratio
• You must have built up at least 20% equity in the property

Specifics

• Home equity loans are also referred to as second mortgages because they function similarly to a standard mortgage, including the fact that home equity loans have specific payback terms and are secured by the property itself
• If approved, you'll receive your payout as a lump sum (minus closing costs and other charges)
• You'll need to make monthly payments on the loan, regardless of whether you use the funds or not, and you'll owe the balance due on the loan if you sell your home
• Typically best for large expenses, like home renovations, but you can essentially use the money as you see fit once you get it
• Many home equity loans offer fixed interest, meaning you will be able to predict how much to budget for payback across the loan's entire lifetime

Home Equity Line of Credit (HELOC)

Requirements

• Similar to that of a home equity loan: you'll need sufficient equity, a good credit score, and other signifiers of creditworthiness, including reliable payment history and a low debt-to-income ratio
• Though HELOCs don't involve closing costs, your home may need to be appraised to determine its current value

Specifics HELOCs function as revolving lines of credit similar to credit cards, meaning they are not an additional loan taken out with your home as collateral.

• If you get a HELOC, you'll be able to take money out from your pool of funds during what's called the "draw period." There's no limit to how much of the funds you can take at one time, but they won't just be paid to you in a lump sum
• No restrictions on how you can use the funds
• Interest only applies for what you take during the draw period
• Monthly payments vary based on how much you've taken from available funds and what the current interest rate is
• You can in theory repay the entire balance of the HELOC during the draw period. If you don't, you'll have a fixed repayment period during which you'll need to pay off the balance

Reverse Mortgage vs. HELOC vs. Home Equity Loan: Similarities and Differences

There are some notable differences between all three of these loan products, including:

• Each one is paid back in different ways and at different times
• Specifics for things like loan terms and interest can vary
• Qualification requirements differ. For example, there is an age requirement for a reverse mortgage, but not for home equity loans and HELOCs
• You typically need to have more equity built up for a reverse mortgage than for a HELOC or a home equity loan

However, these three types of home loans also have some notable similarities, including:

• All three options use your home as collateral to secure the loan
• Borrowers must repay what they receive
• If you are approved for one of these loans, you can use the funds freely
• They can all be positive ways to enhance your financial health as long as you choose wisely and fully understand what you're getting

Want advice on how best to use your home equity? Get in touch with your local Mortgage Advisor today.