A Look into the “Reverse Mortgage” VS “HELOC” (Home Equity Line of Credit) 

You may have heard of reverse mortgages, and the retirement option they can offer to individuals or couples who are “house rich, cash poor.”

For those looking to tap into their home equity in retirement, a reverse mortgage can be a useful tool to allow this.

A home equity line of credit (HELOC) may be another option.

What you may not know: there’s a lot more to be gained by getting a reverse mortgage in 2020, with new product rules in place as well as longtime, little-known benefits that position a reverse mortgage as a better option than a HELOC in many cases.

Rather than simply allowing interest to grow on the reverse mortgage loan to be paid off when the loan comes due, reverse mortgage holders can actually make payments toward the loan.

This allows them not only to keep the interest balance down, but to enjoy a growing credit line that expands over time.

A borrower choice

A reverse mortgage is a loan, and like most loans, it comes with required interest. Unlike most loans, that interest does not need to be paid until the loan comes due—typically when the borrower moves from the home or passes away.

Qualifying borrowers who are 62 or older can receive payments from their home equity under a choice of payment plans, or they can opt to take the reverse mortgage in the form of a line of credit.

But borrowers have another choice: whether to pay interest before it’s due. It may not be an intuitive option, but it can make a major difference in the potential benefit of your home equity when compared to a home equity line of credit.

Consider the following scenarios:

Scenario 1. Jack takes home equity line of credit at age 70. He has a $300,000 home and no existing mortgage.

The following approximations are possible for Jack’s HELOC:

  • Jack can get up to $240,000 loan amount (up to 80% loan-to-value)
  • Jack decides to borrow $100,000 from his available line
  • Interest Rate: Prime + 2.00% amortized over 25 years, or roughly 5.50%
  • Mandatory monthly repayment would be $458/interest only or $614/fully amortized
  • Rate can change monthly
  • Closing costs: $0.00

Scenario 2: Jack takes a reverse mortgage as a line of credit at age 70. He has a $300,000 home and no existing mortgage.

He can opt to repay the interest over time, making monthly payments toward that interest, or simply defer the interest due to repay at a later time.

The following approximations are possible for Jack’s reverse mortgage line of credit:

  • Closing costs: $0.00
  • Jack can get up to $172,000 loan amount (up to 57% loan-to-value)
  • Jack decides to borrow $100,000 from his available line
  • Interest Rate: 1-year annual libor +2.75% – 5.1% fully indexed
  • If Jack “wanted to” he could make a monthly repayment to the interest only of $425 or choose to make any additional repayment to the principle
  • Rate can only change 1 time per year

Reverse mortgage credit line growth

Despite being able to borrow a larger amount under the home equity line of credit, he may actually be better off in the reverse mortgage line of credit scenario for several reasons.

First, Jack is making use of the credit line growth feature that Home Equity Conversion Mortgages (HECMs) offer. If a reverse mortgage credit line is left untouched, the untouched portion will actually grow over time, allowing the borrower to access more home equity in the long run.

This can be a wiser option, particularly for borrowers who are younger, just meeting the qualifying age of 62.

In fact, many financial planners today are advising the use of a reverse mortgage credit line in this way. Reverse mortgages also have new rules including a financial assessment to help ensure borrowers can meet their loan requirements.

Research shows that retirees who use a reverse mortgage line of credit under this credit line options are less likely to run out of money in retirement than those who do not. The line of credit, kept as a “rainy day fund,” or simply as another “bucket” of money to draw from and replenish, is a proven strategy and is gaining appeal in 2016.

Added benefits

Under the reverse mortgage, there is no necessary monthly repayment, versus the home equity line of credit that requires ongoing repayment.

The reverse mortgage also may offer lighter qualifications, especially if the borrower has no existing mortgage and has a strong financial history.

The loan amount offered by a reverse mortgage line of credit may also be more appropriate for older borrowers, who would like to free up some additional cash flow, but may not be prepared to borrow (and repay) a large sum as made available by a HELOC option.

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