Reverse Mortgage vs. Home Equity Loan
If you're over 62 and need to borrow against your home equity, what's the better option? A reverse mortgage or a home equity loan/line of credit?
Both have advantages and disadvantages. A reverse mortgage is costlier, but doesn't have to be repaid until you sell the home. A home equity loan keeps more money in your pocket, but requires regular monthly payments that retirees on a fixed income might find burdensome.
Long-term income vs. short-term cash
The general rule of thumb is that a reverse mortgage works better for someone who needs a long-term, steady source of income, while a home equity loan is better for someone who needs short-term cash that they can repay. But that can vary, depending on individual circumstances.
Reverse mortgages are really just another type of home equity loan. They're officially called Home Equity Conversion Mortgages (HECMs) by the FHA, which insures the vast majority of reverse mortgages made in this country. As with any home equity loan, you borrow money which is later paid back along with any accumulated fees and interest.
Repayment deferred and limited
For seniors, the big attraction of a reverse mortgage is that they don't have to be repaid until they vacate the home. At that time, the mortgage note is typically repaid from the proceeds of the sale of the home, with the remainder going to the borrower or borrower's estate.
A borrower's liability on a reverse mortgage also can never exceed the value of the property securing the note - whatever the home eventually sells for is the most the lender is entitled to. So borrowers who choose to receive their payments in the form of regular installments for as long as they own the home never have to worry about the money running out.
The downside of a reverse mortgage is the cost. There are substantial closing charges, the interest rate is higher than on a conventional home equity loan or line of credit, and there are insurance fees that run about $25-$35 a month. All of which means you may not have much equity left when it comes time to vacate your home - which could be a problem if you need that money to help pay for assisted living costs or other arrangements.
As an alternative to a reverse mortgage, some borrowers have tried setting up a home equity line of credit (HELOC) and drawing out regular amounts over a period of time. While this results in lower costs for interest and fees, it's also a very risky approach. The lender could cut off your line of credit at any time and demand repayment of the loan, meaning you'd likely have to sell the property. This really only works if you're planning to stay in the property only a short time longer, and even then you have to make regular monthly payments.
A reverse mortgage can be used for short-term financial needs, such as major home repairs or sudden medical expenses, if repaying the loan would be difficult. Reverse mortgages can be taken out as a limited series or immediate payouts or as a line of credit to cover short-term expenses. Again, the loan doesn't have to be repaid as long as you live in the home, but interest and fees will accumulate in the meantime.
A standard home equity loan or line of credit, on the other hand, probably makes more sense for short-term expenses if you can afford the regular payments they require, since the total cost is less than for a reverse mortgage.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.