Reverse Mortgage Vs. Home Equity Loan Or HELOC: How To Choose

One of the primary benefits of buying a house is the ability to build home equity. Equity is the cash value in your home that increases as you pay your mortgage. After you reach a certain percentage of equity in your home, you may be able to convert that equity to cash through a reverse mortgage, home equity loan or home equity line of credit (HELOC).

While older homeowners have exclusive access to reverse mortgages, any homeowner with sufficient equity can borrow money against it. But is a reverse mortgage, home equity loan or HELOC right for your goals? You’ll want to consider how each option functions, as well as the pros and cons, before determining which works best for your financial situation.

Keep in mind that Rocket Mortgage^® doesn’t offer reverse mortgages or HELOCs.

Reverse Mortgage Vs. Home Equity Loan Vs. HELOC

A reverse mortgage, home equity loan and HELOC are all options that help homeowners access their home equity. You can calculate home equity by subtracting your mortgage balance from your home’s value. For instance, say you have $200,000 left on your mortgage, and your home is worth $300,000. Therefore, you have $100,000 in home equity to leverage through various financial tools. Each has benefits and drawbacks that fit specific financial situations.

Reverse Mortgage

A reverse mortgage is a tax-free loan based on home equity and is available to homeowners age 62 and older. You can get a reverse mortgage only on your primary residence. The money you borrow first pays off the rest of your mortgage (if you have one), then the rest of the money comes to you. You’ll no longer have to make monthly mortgage payments on the home, but property taxes, homeowners insurance and home maintenance will still be your responsibility.

You don’t have to repay the loan until you sell the home, change your primary residence or pass away. When any of these conditions occur, the reverse mortgage balance plus interest is due to your lender.

Types Of Reverse Mortgages

There are three types of reverse mortgage: home equity conversion mortgage (HECM), single-purpose reverse mortgage and proprietary reverse mortgage.

Home Equity Conversion Mortgage (HECM)

HECMs are the most popular type of reverse mortgage because the funds are flexible and they come with protections from the Federal Housing Administration (FHA). With a HECM, you can use the money you receive however you wish. You can opt for a lump sum payment, monthly installments or a line of credit depending on the type of HECM you get.

Thanks to FHA regulations, HECMs are nonrecourse loans. That means you’ll never owe more than your home is worth.

Single-Purpose Reverse Mortgage

A single-purpose reverse mortgage comes with conditions from your lender to use the funds solely for an approved reason, such as home repairs or tax payments. Access to these loans varies by region and the local organizations offering them. However, they’re generally less expensive than HECMs.

Proprietary Reverse Mortgage

Because HECMs and single-purpose reverse mortgages are for loans up to the conforming limit, proprietary reverse mortgages are usually for high-value homes that exceed those limits. They come from private lenders and therefore have fewer restrictions and regulations than other reverse mortgages.

Pros Of Reverse Mortgages

Reverse mortgage loans have the following advantages:

• No monthly payments. Your reverse mortgage balance is only due if you sell your home, move or pass away. Otherwise, you only have to pay your property taxes and homeowners insurance.
• You can stay in your home. A reverse mortgage pays off your mortgage balance and allows you to live in your house.
• No income requirements. You can qualify for a reverse mortgage if you’re struggling financially to help stabilize your circumstances.
• The money is tax-free. As a result, you won’t have to claim your reverse mortgage as income when filing taxes.
• You can target significant life expenses. Specifically, with a HECM, you can use the funds for one or more crucial items, such as home repairs, living expenses, credit card debt or medical bills.
• You won’t leave your heirs in a bind with a HECM. If you pass away, your heirs can give the title to the mortgage lender and walk away without spending a penny. They can also sell the home to cover the balance due and keep the remaining proceeds. Or, they can refinance the reverse mortgage and start making monthly payments on a new loan.

Cons Of Reverse Mortgages

If you have a reverse mortgage, you might have to navigate the following drawbacks:

• Your loan balance will increase if you don’t make interest payments. This situation could snowball into a balance higher than your home’s value. If you don’t have a HECM, you’ll need to pay the difference. That could force you or your heirs to give up the home when the balance is due.
• You're responsible for additional fees. You’ll have to pay origination fees to your lender, closing costs and insurance costs to the FHA (if you have a HECM). While you might be able to roll these charges into your loan, you’ll receive less money from the loan and owe more when the loan is due.
• You likely can’t use the mortgage interest deduction. Generally, you can’t deduct mortgage interest on your tax return.
• The loan could affect Medicaid and Supplemental Security Income. Be sure to speak with a financial advisor before applying for this loan.
• You could risk entering foreclosure. You can lose your home through foreclosure if you don’t pay property taxes, HOA fees or homeowners insurance, or if you fail to maintain your home.
• Your home could lose primary residence status. If you have to go into an assisted living facility, your home could no longer be considered a primary residence. You could also face other challenges, such as adding a spouse to your loan if you marry after receiving the reverse mortgage.

Home Equity Loan

A home equity loan is a lump sum you receive upfront and then repay over a predetermined period of time. Home equity loans let you tap up to 85% of your equity, depending on certain factors, including your lender and credit score.

You can use the money from a home equity loan in any way you like. Unlike a reverse mortgage, where the loan comes due under specific conditions, you repay a home equity loan through monthly installments that begin soon after receiving the loan. As a result, home equity loans are often called second mortgages because you make monthly payments on that loan along with your original mortgage.

Home equity loans can come from equity in your primary or secondary home and have fixed interest rates. This loan type can range in size, from a sum that helps you pay off a high-interest debt to a sum that pays for a home addition.

Pros Of Home Equity Loans

You’ll enjoy the following benefits with a home equity loan:

• No limitations on using the money. You can use the lump sum in any way you choose, like making home improvements or funding a child’s college tuition.
• You may qualify for this loan more easily than other loans. Lender requirements for your equity, credit score and debt-to-income ratio are less stringent for home equity loans.
• These loans have lower interest rates than credit cards. Credit cards usually have double-digit interest rates, while home equity loan rates are significantly lower.
• You’ll have fixed monthly payments. Home equity loans have fixed interest rates, so your monthly payment will remain consistent throughout the life of the loan. This feature allows you to budget for an unchanging loan payment.
• You can access the funds immediately in one lump sum. You can tackle significant expenses sooner with a lump sum instead of monthly installments.
• Mortgage interest may be tax deductible. You can deduct the interest on up to $750,000 for your home equity loan as long as it's being used to renovate or remodel your home.
• Your repayment period can be longer than other loans. This can give you more time to pay off your balance with lower monthly payments.

Cons Of Home Equity Loans

Home equity loans also come with these pitfalls:

• You risk foreclosure if you default on the loan. Like your first mortgage, a home equity loan uses your home as collateral.
• You’ll have two loans to pay off if you sell your home. As a result, selling your home could put you into a daunting financial position because your home sale might be insufficient to repay your first and second mortgages.
• You’ll have to pay closing costs. Home equity