Comparing a Reverse Mortgage vs. a Home Equity Loan
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Weighing the benefits and drawbacks of a reverse mortgage vs. a home equity loan isn’t always an easy task. Both loan types allow you to tap your available home equity for virtually any purpose. Both may also come with low interest rates and terms compared to other financial products — depending on your creditworthiness.
For many Americans, a home equity loan could be the better choice. However, senior homeowners who qualify may lean toward a reverse mortgage.
What is a reverse mortgage?
A reverse mortgage is a home loan made exclusively for senior homeowners who are at least 62 years old. Instead of making payments to a lender, as with a traditional “forward” mortgage, reverse mortgage borrowers receive monthly payments, a lump sum or a hybrid of both from their lender.
This type of loan can make sense for seniors who have a significant amount of equity in their home, or own it outright with no outstanding mortgage balance to pay. The most common type of reverse mortgage is the home equity conversion mortgage (HECM), which is insured by the Federal Housing Administration (FHA).
Keep in mind you can lose your home in a reverse mortgage — for failing to pay your homeowners insurance or property taxes, for example — since the property is used as collateral for the loan.
Reverse mortgage pros and cons
|You don’t make monthly payments to your lender||You only qualify if you’re aged 62 or older|
|You can supplement your income or meet other financial goals||You’re responsible for maintaining insurance, tax and homeowners association payments on your own|
|You won’t end up underwater on your loan||You lose the equity built in your home|
|You can stay in your home until you move, pass away or sell||You’ll pay high upfront costs and fees|
What is a home equity loan?
A home equity loan is another mortgage product that allows you to borrow against your home’s equity. It’s disbursed in a lump sum and repaid in fixed monthly installments over a set term.
It’s a forward mortgage, and is also referred to as a second mortgage, because it’s paid off after a first mortgage in the event of a foreclosure sale. A first mortgage is a home loan used to purchase a home.
Home equity loan pros and cons
|You can use home equity loan funds to meet other financial goals||You’re responsible for two mortgage payments each month (if you still have a first mortgage)|
|You’ll have a fixed interest rate||You lose most of the equity built in your home|
|Your monthly payment amount won’t change over the loan term||You could lose your home to foreclosure if you default|
|You might be able to deduct the loan’s interest||You’ll pay closing costs, which range from 2% to 5% of the loan amount|
Comparing a reverse mortgage vs. home equity loan
|Reverse mortgage||Home equity loan|
|Who qualifies?||Homeowners aged 62 or older with at least 50% equity||Homeowners of any age with at least 15% equity|
|Minimum credit score?||Not applicable||620|
|Monthly payment?||No monthly payments to lender required||Yes (amount will depend on interest rate, amount borrowed and term)|
|Interest rate?||Can be a fixed or variable interest rate||Usually a fixed interest rate|
|Closing costs and fees?||Up to $6,000 in lender fees; 2% of the loan amount for mortgage insurance; and various other fees||2% to 5% of the loan amount|
A reverse mortgage might work better if …
- You’re at least 62 years old, own your home free and clear or have a small outstanding mortgage balance.
- You’re retired and need supplemental income to comfortably maintain your lifestyle.
- You plan to keep your home and age in place.
- You have heirs who would be in the position to buy or sell your home and pay off the reverse mortgage.
A home equity loan might work better if …
- You’re under the age of 62 but would still like to tap your home equity.
- You’re gainfully employed and have a stable income.
- You want to take advantage of potential tax benefits of repaying the loan, such as the mortgage interest deduction (if you used the money for home improvements).
3 considerations when weighing a reverse mortgage vs. home equity loan
Here are the key issues to think about when deciding if a reverse mortgage vs. a home equity loan is right for you:
- Which loan will have lower lifetime costs? HECMs may have higher upfront costs than home equity loans, but it’s important to consider your ongoing costs. For example, HECMs have an annual mortgage insurance premium that costs 0.5% of the loan amount.
- Can you keep up with your supplemental expenses? While a reverse mortgage might be tempting, remember that you have to keep up with property taxes, homeowners insurance premiums, repairs, maintenance and other homeownership costs. If your finances are strained and you can’t meet these obligations, you may want to consider other options to boost your income.
- What about your spouse? Remember to factor in the implications of a reverse mortgage for your spouse. If you take out a HECM, an eligible non-borrowing spouse may be able to live in the home after you die or move out, provided they keep up with insurance, taxes and maintenance. However, they won’t continue to receive reverse loan payments.