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Homeowners have a few financing options to convert their home equity into cash. Deciding between a home equity line of credit (HELOC) vs. reverse mortgage? There are some key differences in eligibility requirements, loan repayment, and how funds are disbursed to consider when choosing between these loan options.
Read on for our reverse mortgage vs. HELOC comparison to determine which option is right for your financial goals.
Key Points
• HELOCs function similarly to credit cards, allowing borrowing as needed up to a credit limit based on home equity.
• Reverse mortgages are typically for homeowners aged 62 or older.
• HELOCs require monthly payments, while reverse mortgages do not require monthly payments.
• HELOCs have variable interest rates, making monthly payment amounts unpredictable.
• Reverse mortgage repayment is due upon moving, selling the house, or death.
How a HELOC Works
HELOCs are popular for their flexibility, which allows users to borrow money as needed. So, what is a HELOC and how does it work?
A home equity line of credit is a revolving line of credit similar to a credit card. HELOCs come with an approved credit limit; borrowers have the ability to draw funds as needed up to that limit until the draw period ends (often 10 years). During the draw period, borrowers typically just make interest-only payments on the funds they’ve withdrawn, although if they pay down the principal they can access funds up to their credit limit again.
After the draw period ends, the HELOC enters the repayment period where borrowers pay back both the principal and interest for a fixed term. Keep in mind that HELOCs with variable interest rates are most common, meaning that monthly payments can change over the repayment period.
Borrowers use their home equity to secure a HELOC, putting their home at risk of foreclosure if the loan goes into default. Lenders may let borrowers tap into 85% of their home’s value, minus what is still owed on the mortgage, with a HELOC. In other words, homeowners need to have at least 20% home equity to qualify for a HELOC.
For example, a homeowner with a property valued at $500,000 and a mortgage balance of $300,000 could qualify for up to $125,000 credit limit with a HELOC.
Property Value ($500,000) x 0.85 = $425,000 – Mortgage Principal ($300,000) = Estimated HELOC ($125,000)
Prospective borrowers can calculate home equity to get a ballpark estimate before applying for a HELOC. Keep in mind that lenders may require a home appraisal for HELOC approval.
How a Reverse Mortgage Works
A reverse mortgage also allows homeowners to borrow against the equity they’ve built in their home. But how do reverse mortgages work compared to a HELOC?
The most common type of reverse mortgage, a home equity conversion mortgage (HECM), is for homeowners aged 62 or older. It allows them to take out between 40% and 60% of their home’s appraised value in cash. With a reverse mortgage, borrowers can receive funds in a lump sum, through monthly payments, or as a line of credit. To qualify for this type of reverse mortgage, many lenders require owners to have at least 50% equity in their home.
When you take out a reverse mortgage, you aren’t required to make monthly payments. Instead, loan repayment is due when borrowers sell, move out, or pass away. In the meantime, interest and fees accumulate each month, increasing the loan balance over time.
HECMs are not the only type of reverse mortgage. When comparing HECM vs reverse mortgages, it’s important to note that HECMs are insured by the U.S. government and property values are capped at $1,249,125 for lending purposes.
Other types of reverse mortgages include single-purpose reserve mortgages and proprietary reverse mortgages. Single-purpose reverse mortgages allow borrowers to tap equity for specific expenses approved by the lender, such as paying for home repairs or property tax. Meanwhile, proprietary reverse mortgages could be an option for borrowers with an appraised home value above the HECM loan limit of $1,249,125.
Keep in mind that borrowers are still required to continue paying property taxes, homeowner’s insurance, and other ongoing costs like HOA fees with a reverse mortgage. Also note that non-borrowing spouses can remain in the home if a borrower moves into long-term care or dies if certain conditions are met.
HELOC vs Reverse Mortgage: Key Differences
There are some notable distinctions between how a HELOC vs. reverse mortgage works. Here’s a closer look at several key differences to keep in mind when weighing your financing options.
Eligibility Requirements
The eligibility requirements to take out a home equity line of credit vs. reverse mortgage differ significantly.
To qualify for a HELOC, borrowers are evaluated according to their creditworthiness, ability to repay the loan, and how much home equity they have. Generally, homeowners need 20% home equity to be eligible for a HELOC, though qualifying with 15% home equity may be possible in some cases. Having a credit score of at least 680 and a debt-to-income ratio below 45% will also help borrowers qualify for a HELOC.
Meanwhile, reverse mortgages carry stricter eligibility requirements. Namely, borrowers must be 62 or older and live in the home as a primary residence. While there isn’t a fixed equity requirement, homeowners usually need at least 50% home equity. If applying for an HECM, which is insured by the Federal Housing Administration, borrowers need to be free of federal debt and participate in counseling from an approved reverse mortgage counselor.
Repayment Structure
How repayment works also varies between a HELOC and reverse mortgage.
With a reverse mortgage, the loan term continues for as long as the borrowers live in the home and continue managing upkeep and paying property tax and insurance. Borrowers aren’t required to make monthly payments with a reverse mortgage. Rather, the accrued loan amount is due when the borrower moves or upon their death.
HELOC repayment includes two phases: the draw period and repayment period. During the draw period, borrowers are often only required to pay interest on the amount they’ve taken out. Once the draw period ends, no further funds can be taken from the credit line and borrowers begin paying back the total borrowed amount plus interest. The repayment period on a HELOC may span up to 20 years.
Costs and Interest Rates
The cost of borrowing is another key difference to note when comparing a HELOC vs. reverse mortgage.
HELOCs may be available with little to no closing costs. Interest rates on a HELOC tend to be variable, meaning they’re subject to change over the loan term based on market conditions. Note that interest payments on a HELOC can be tax deductible if used toward improving the property used to secure the loan, though you’ll want to consult a tax advisor about any tax matter to help make sure you are following the rules.
Like conventional mortgages, reverse mortgages carry considerable closing costs, including origination and appraisal fees. If taking out an HECM, borrowers pay an upfront mortgage insurance premium that’s 2% of the home’s appraised value (MIP), plus an annual MIP equal to 0.5% of the loan balance. Reverse mortgage interest rates can be fixed or variable depending on the loan type.
Pros and Cons of Each Option
Both financing options come with their own potential advantages and downsides.
| HELOC Pros and Cons | |
|---|---|
| Pros | Cons |
|
• Funds can be withdrawn as needed and used for a variety of expenses. • Pay interest only on the amount taken out. • Closing costs may be lower than other financing options, such as home equity loans. |
• Using your home as collateral puts it at risk of foreclosure if you default on the loan. • Less predictable monthly payments due to variable interest rates. • May carry annual fees to keep the line of credit open. |
| Reverse Mortgage Pros and Cons | |
|---|---|
| Pros | Cons |
|
• Lets borrowers turn home equity into cash to support them in retirement. • No monthly payments, and funds received from a reverse mortgage are not taxable. • Repayment isn’t required until the last surviving borrower dies, moves out, or decides to sell. |
• Interest rates are typically higher than conventional mortgages. • Comes with high upfront closing costs, including origination fees and MIP. • People living in the house besides a spouse could be displaced when the borrower vacates the property. |
Recommended: Reverse Mortgage Pros and Cons
When to Choose a HELOC vs a Reverse Mortgage
Deciding between a HELOC vs. reverse mortgage comes down to your financial needs and long-term goals. It’s also worth considering the cost implications of one financing option versus the other.
While reverse mortgages are designed for borrowers 62 or older, a home equity line of credit for retirees could make sense in certain scenarios. For example, retirees could leverage a HELOC for medical bills or a home improvement project with uncertain costs.
A reverse mortgage could make more sense if you plan to remain in your home for an extended period and could utilize funds to supplement cashflow in retirement. Borrowers living in locations where home values are increasing could also benefit from a reverse mortgage.
The Takeaway
Both HELOCs and reverse mortgages let homeowners tap into their home equity to fund a variety of expenses. Each financing option has its potential downsides, and there are other alternatives to consider. A reverse mortgage could be advantageous for supplementing retirement funds without having to make monthly payments. Meanwhile, other borrowers may opt for a HELOC for low closing costs and flexibility in how funds are used.
SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $750,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.
FAQ
What is a reverse mortgage line of credit and how does it compare to a HELOC?
A reverse mortgage line of credit functions like a HELOC in that borrowers can access funds from their reverse mortgage as needed instead of taking a lump sum. Unlike a HELOC, a reverse mortgage line of credit does not require monthly interest payments. However, the most common type of reverse mortgage, a home equity conversion mortgage (HECM) is limited to homeowners age 62 or older.
Can you have both a HELOC and a reverse mortgage?
It is unlikely that homeowners could have both a HELOC and a reverse mortgage. Reverse mortgages come with a first-lien requirement, and lenders may not approve a second lien on a property with a reverse mortgage.
Does a reverse mortgage affect your heirs?
A reverse mortgage can reduce the home equity in a property that the homeowner’s heir would inherit. Since a reverse mortgage comes due upon a borrower’s death, heirs may choose to buy or sell the property to settle the debt. However, heirs would not be required to pay back more than the property is worth with a reverse mortgage.
What happens to a HELOC if home values drop?
A significant drop in home value could prompt a lender to lower the line of credit or freeze a HELOC to prevent more funds from being withdrawn.
What are the age requirements for a reverse mortgage vs. a HELOC?
The most common type of reverse mortgage, the Home Equity Conversion Mortgage (HECM) has a minimum age requirement of 62. The minimum age requirement for a HELOC is typically 18 years old.
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