Reverse Mortgage vs HELOC – What’s the Smarter Choice?

November 3, 2022 By Michael Branson 15 comments

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.” A reverse mortgage can be a valuable tool for those looking to tap into their home equity in retirement.

This article will compare the traditional HELOC (Home Equity Conversion Mortgage) and the HECM (Home Equity Conversion Mortgage).

What you may not know about Reverse Mortgages

There’s a lot more to be gained by getting a reverse mortgage in 2023. With new product rules in place and long, little-known benefits, a reverse mortgage is often positioned as a better option than a HELOC.

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 make payments toward the loan.

This allows them to keep the interest balance down and enjoy a growing credit line that expands over time.

With a Reverse Mortgage, You Can Also Make Repayments

A reverse mortgage is a loan; like most loans, it comes with the 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 62 or older can receive payments from their home equity under a choice of payment plans or take the reverse mortgage as a line of credit.

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

Reverse Mortgage vs. Home Equity Loan Examples

Scenario 1.

Jack takes home an 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 defer the claim due to repay later.

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
The rate can only change 1 time per year

Reverse Mortgages Offer a Unique Credit Line Growth Feature

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

First, Jack uses the credit line growth feature that Home Equity Conversion Mortgages (HECM) offers. Suppose a reverse mortgage credit line is left untouched. In that case, the unused portion will grow over time, allowing the borrower to access more home equity in the long run.

This can be a wiser option, particularly for younger borrowers just meeting the qualifying age of 62. Many financial planners today advise using a reverse mortgage credit line in this way.

Reverse mortgages also have new rules, including a financial assessment to help ensure borrowers 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 was kept as a “rainy day fund” or simply as another “bucket” of money to draw from and replenish a proven strategy gaining appeal in 2016.

Relaxed Qualifications

Under the reverse mortgage, there is no necessary monthly repayment versus the home equity line of credit that requires ongoing compensation. The reverse mortgage also may offer lighter qualifications, especially if the borrower has no existing mortgage and has a solid 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.

HELOC vs Reverse Mortgage Product Comparison

Compare Features	Traditional Home Equity Line of Credit (HELOC)	Home Equity Conversion Mortgage (HECM)	Proprietary Reverse Mortgage (Non-FHA)
Borrower Minimum Age	18	62	55
Line of Credit Term	10 Years	Lifetime	10 Years
May Be Frozen	Yes*	No*	Yes*
Line of Credit Growth Rate	No	For Life	7 Years
$0 Monthly Payment Option	No	Yes	Yes
Income Requirements	Yes	Limited	Limited
Credit Score	680+	Any	Any
Reserves	2-6 Months PITI	Any	Any
Low/No Closing Costs	No	No	Yes
Fixed Interest Rate	No	No	No
Common Index	Prime Rate	Treasury	Treasury

*HELOC loans generally permit lenders to freeze or reduce a credit line if the home's value declines significantly. You must be prepared to make this “balloon payment” by refinancing, obtaining a loan from another lender, or using other means. You could lose your home if you cannot make the balloon payment.
Source: https://files.consumerfinance.gov/f/201204_CFPB_HELOC-brochure.pdf
**All line of credit programs may be frozen if you fail to maintain taxes and insurance or leave your home as your primary residence. If you enter bankruptcy, courts will not allow you to incur new debt while in BK proceedings, and therefore your line of credit during this time could also be frozen.

Reverse Mortgage vs. HELOC FAQs

What is the difference between a reverse mortgage and HELOC?

A HELOC is a line of credit that requires monthly payments and can be closed whenever the lender chooses. The reverse mortgage is insured and guaranteed to be available under the loan terms by HUD. The borrower is not required to make monthly repayments for as long as they live in the home and pays the taxes and insurance in a timely manner.

Which is better, a Home Equity Line of Credit or a Reverse Mortgage?

The better option will depend solely on an individual’s circumstances. A HELOC is typically less expensive to establish, benefiting those looking for short-term financing. On the flip side, a HELOC comes with several disadvantages as well. With a HELOC, you have mandatory monthly payments, and the available line of credit is not guaranteed. It can be frozen or eliminated at the lender’s sole discretion. The open-ended period (when you can draw funds) usually lasts only ten years. The mandatory monthly payments also increase significantly when you reach the recast period (usually at the end of 120 months).

The loan goes from interest only to principal and interest repayments to pay off over the remaining term. Failure to make timely payments can damage your credit and even result in foreclosure. A Reverse Mortgage will be more expensive to establish the loan as there is mortgage insurance due to HUD, so it is not designed to be a short-term financing solution as it is intended to be the last loan you ever need. With a Reverse Mortgage, your available funds, which can be accessed as a line of credit, scheduled monthly advances, initial cash disbursement, or even a combination of all 3, are guaranteed for as long as you live in the property by HUD. Your line of credit cannot be frozen or eliminated due to market fluctuations, and the unused line of credit grows in availability over time.

The funds remain available for as long as the loan is in good standing (the borrower lives in the property as a primary residence and maintains taxes and insurance). There are no mandatory monthly payments on a reverse mortgage, so you cannot damage your credit by missing a monthly payment. Voluntary payments are permitted without any prepayment penalty.

What makes a reverse mortgage line of credit a better option?

The reverse mortgage line of credit grows over time on the unused portion of the line. Not only can it not be closed by the lender, but the amount available to borrowers increases over time if you do not use all the funds available to you early in the term of the loan (HELOCS can be closed at any time the lender desires, even if you depended on the availability of the funds). Additionally, a reverse mortgage line of credit is available as long as the borrower lives in the property as their primary residence and maintains the taxes and insurance on the home. In contrast, a HELOC is usually only available for a maximum of 10 years.

What are the disadvantages of a reverse mortgage line of credit?

The disadvantage of a reverse mortgage is that it costs more to establish. If you want to pass the house down as a large inheritance and think you need help to make payments on the reverse mortgage, the asset you would pass would be less (however, this would also mean you should not get a HELOC either).

Are the qualifications different for reverse mortgages vs. HELOCs?

The qualifications are different for HELOCs and reverse mortgages in that reverse mortgages use a residual income method of qualification, vs. the HELOC utilizes an ability-to-repay approach. The residual income method looks at all the borrower’s outgoing debts subtracted from their income. The borrower must have a minimum amount left to live each month.

The ability to repay considers the borrower’s debts as a ratio of the borrower’s total income to determine the borrower’s ability to repay the obligation. The residual income method HUD employs for the reverse mortgage is much easier to qualify for most borrowers, especially those on fixed incomes.

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About the Author, Michael G. Branson | Mike@allreverse.com

Michael G. Branson CEO, All Reverse Mortgage, Inc. and moderator of ARLO™ has 40 years of experience in the mortgage banking industry. He has devoted the past 19 years to reverse mortgages exclusively.

15 Comments on this Article

Cathy
April 4th, 2023

Hi Arlo,

I have a question regarding the HECM line of credit. I understand that it grows over time. My question is, when the borrower has an untapped line of credit, do those funds go to the borrower at the end of the loan?
Reply to Cathy
- ARLO™
  April 4th, 2023
  
  Hello Cathy,
  
  The "end of the loan" is when the home is sold, the borrower refinances the loan with a new loan, or the borrower passes. The line of credit available to the borrower at that time would not be paid out to anyone, including the borrower if the borrower is still living, but then, no repayment is required of the funds never borrowed. Had the borrower borrowed those funds, and the interest had accrued, that amount would have been due when the loan was paid in full from the home sale. Since the borrower did not use those funds, they are not owed, and the entire equity is available to the borrower or their heirs from the sale or refinance proceeds.
  
  Think of it like a credit card. If you had a credit card with an available line of credit of $100,000 and never used the card, then you closed that account, and no one paid you $100,000 when you closed the account. You close the account and owe nothing. Now if you started with a line available of $10,000 and every year, the bank raised your credit limit by $10,000, and in 10 years you had a line of $100,000, and you closed the account, you still would owe nothing if you didn't use the money. If you had used the funds, you would have owed the money you used and would have paid any interest you accrued on the funds you borrowed.
  
  With a reverse mortgage, if you keep your line for many years without using the money, the line available to you grows by the amount you would have accrued in interest and Mortgage Insurance Premiums (MIP) on the outstanding balance as if you had borrowed the full amount on day one. This is one of the all-time best insurance policies. If you never use the money, don't accrue any interest on it, and you or your heirs do not have to pay back any portion of the loan you didn't borrow. Your line also grows during this time so that if you need the money later, you have more money available to use.
  
  I hope this makes it easier to understand. You are not alone, as many people think there is money that is funded and set aside in an account somewhere that you get at the end of the loan. If that were the case, though, you would also be accruing interest on those borrowed funds from the day you first got the loan, even when you were not using those funds. This way, you only accrue interest on borrowed funds as needed, and you or your heirs do not repay any funds you do not end up borrowing. It's the best of both worlds. The line grows, so more money is available to borrowers later if you need it, and if you do not, you do not pay interest on the money.
  Reply to ARLO
Mike B.
March 31st, 2023

Hi Arlo,

I have a HELOC. The draw period has ended. It's now in the repayment phase. The HELOC balance is less than half the home's value. Could I use a reverse mortgage to lower my payment and pay only the interest to keep the balance from growing?
Reply to Mike
- ARLO™
  March 31st, 2023
  
  Hello Mike,
  
  HUD has rules about paying off existing liens and how much can be used based on when the existing loan was taken or in the case of HELOCs, the most recent draws if you exceed certain thresholds of the Home Equity Conversion Mortgage (HECM) reverse mortgage program, so I just need to caution you that when you talk to a lender be sure to let them know if you have taken any draws on the HELOC in the past 12 months.
  But now having said that, yes, if you meet the parameters of the HUD program, it would be a fantastic time to rid yourself of that HELOC!
  Now that you are in the repayment period, you are fully amortizing the balance (probably over 20 years) and are no longer able to draw from the HELOC anyway. The HUD HECM program requires no monthly payment but there is no prepayment penalty so if you choose to make a payment, you can at any time, but it is entirely up to you.
  Therefore, you can choose to "lower your payment" by making a payment of any amount you wish, or you can eliminate your payment if that is what you would rather do (you still need to pay your taxes and insurance in a timely manner).
  
  You might want to start with a trip to our online calculator to see what you can expect to be able to receive under the program. There is no obligation, and you never need to supply information such as social security numbers, etc.
  Reply to ARLO
Bob K.
November 4th, 2022

Hi ARLO,

I enjoyed reading your informative article on Heloc's. I currently have on
that is over the $250k FDIC guarantee and my question is twofold.

Is my used balance over $250k covered by the FDIC and secondly, what happens if my lender goes insolvent? Also, assuming there is another lender that assumes my current loan, does my unused balance of the HELOC remain as is, or is no longer available?

Any help on this is appreciated.
Reply to Bob
- ARLO™
  November 4th, 2022
  
  Hi Bob,
  Those are good questions that you should ask your HELOC lender. Your unused balance of a HELOC is not guaranteed to be available by anyone. The FDIC insures deposits, they do not guarantee that unused loan balances will be available at any time in the future. If your lender becomes insolvent or
  even just changes their lending guidelines or products available, you would be subject to those changes. If the lender becomes insolvent, the loan would be transferred to a new lender (probably through acquisition of assets from the new, stronger lender) and the new lender may or may not keep the loan active going forward. Neither the current lender nor an acquiring lender could not alter the terms of any existing funds you had already borrowed. You would be subject to the terms to which you agreed as specified in your loan documents. But either can freeze the loan and no longer issue any further advances if they decided that the loan parameters are not consistent with their acceptable risk constraints or that they no longer offer this type of financing.
  Lenders can change their underwriting guidelines and require you to "requalify" based on the new terms or based on their perceived market changes, or they can close the program entirely at any time. I don't know what the rules are about costs, when Wells Fargo did this to me in 2009, they froze the account and offered to reappraise the property at their expense, but they also wanted to completely re-underwrite the loan based on their current guidelines (and they were not insolvent). Property values had fallen at the time, and they were just concerned about their portfolio. In addition to using the new lower property values, they also drastically lowered the percentage of the value of the home on which their loan would be computed so the combination of the two dropped the amount of the HELOC they would offer to a fraction of the loan I previously had. Since I was not using the loan at the time, I chose to close the loan rather than agree to the reduced amounts.
  This is why we always tell people to compare the options when making their decisions. A HELOC is a much less costly option to start (fewer fees, etc.). However, the HELOC typically has an interest only period for about 10 years during the draw period at which time the draw period ends and is replaced with the repayment period (usually 20 years). During this time, payments can go up as much as 2 - 3 times what borrowers were paying during the draw period. The HECM has all the costs front-loaded. But the line is always available and the amount available grows on the unused portion. You should check your loan to see if it has similar features and then ask yourself what your projected income will be in 10 years when the payment increases. No one knows what the future will bring but if this is how your loan is structured and if that does extend beyond an anticipated retirement or other income changing event, it's worth considering. We get a lot of borrowers who get hit with the payment change on a HELOC and realize they are not in a position to make the higher payment with the 20-year amortization for payment in full on the balance of the loan at that time and sadly some no longer qualify for a reverse mortgage with their equity at that time.
  If you think you will only need the loan for a few years, the HELOC is probably the best option. If you think you will be there for life, a HECM reverse mortgage won't "sneak up on you" with a large payment increase and can never be frozen at the lender's discretion. They are both worth reviewing.
  Hope that helps!
  Reply to ARLO
Dan C.
June 30th, 2022

Hi Arlo,

I understand that the amount of the current loan, the appraised value of the property and the "full assessment of the borrower's situation come into play:

1. Is there a percentage number between the appraised value of the property vs. the amount of the loan allowed come into play?
2. Does the credit worthiness of the applicant come into play?
Reply to Dan
- ARLO™
  July 6th, 2022
  
  Hello Dan,
  
  I am not sure I fully understand your question so forgive me if I answer from a different perspective but I will give it my best effort. A reverse mortgage is not like a traditional forward loan in the sense that an underwriter of a traditional forward loan may look at the borrower's qualifications and if he/she feels that the borrower is not qualified enough for the requested loan amount, they may approve the loan at a reduced amount.
  With a reverse mortgage, the borrower receives a benefit or loan eligibility based on the property value, loan program, the borrower's age and then it is a matter of whether or not the borrower and property qualify under the HUD and lender's requirements. The underwriter cannot reduce the loan eligibility by 5 - 10% and offer the borrower a lower loan amount if the borrower does not meet HUD's or the lender's normal requirements. The amount a borrower receives with a reverse mortgage is still determined by the borrower's age, the value of the home and the interest rates in effect.
  The older the borrower, the higher the percentage of the home's value (up to the maximum HUD lending limit) the borrower will receive under the program. The higher interest rate, the less the borrower will receive. This is why lender's use a reverse mortgage calculator based on the HUD calculations. HUD posts their Principal Limit Factor Tables on their website at https://www.hud.gov/program_offices/housing/sfh/hecm. To see what you can expect for your age, you need to be sure to use the age of the youngest borrower, the expected rate (not the initial rate if it is an adjustable-rate loan) and the value will be the appraised value or HUD lending limit (which is currently $970,800), whichever is less.
  
  HUD does have the ability to use a set-aside to pay the taxes and insurance on the property under certain circumstances that are laid out in their financial assessment guidelines that will help some borrowers that might have otherwise been declined due to certain credit history issues or those who are short of the residual cash requirement, but you would need to speak with your lender to determine if that would work for your circumstances.
  Prior to 2014, the credit of a reverse mortgage borrower was not a factor in the underwriting of the loan but the program came under intense scrutiny by congress due to the substantial losses it was experiencing. Even with no mortgage payments, borrowers were defaulting at a very high rate on taxes and insurance and the losses were endangering the Mortgage Insurance Premium (MIP) fund.
  HUD needed to take steps to shore up the program and some in Congress were calling for the elimination of the reverse mortgage program to protect the MIP fund. In 2015 HUD implemented the financial assessment guidelines they announced at the end of 2014 which now requires lenders to take the credit worthiness of the borrowers into consideration for reverse mortgages.
  Reply to ARLO
Ron
January 29th, 2020

I have a line of credit reverse mortgage balance. If I refinance how that would affect the line of credit. We are 65 now, could we get a higher percent of the property value?
Reply to Ron
- ARLO™
  January 30th, 2020
  
  Hello Ron,
  If you choose to refinance your current loan, the balance owed would be repaid with the new reverse mortgage. Any unused portion of the line would not be part of that pay off because you don't have to repay what you didn't borrow.
  So basically, the entire motivation for a refinance would have to be measured based on your current benefits as determined by current circumstances. Those circumstances are your ages, current interest rates and HUD guidelines in effect when you look at the refinance.
  Some borrowers would benefit greatly from a refinance who had higher interest rates and whose property values have increased and might also be under HUD's old parameters where the MIP renewal is 1.25% instead of the current .50%.
  However, you have to remember that you are going to pay the difference between the up-front mortgage insurance premium (UFMIP) that you paid on the initial loan and what the UFMIP would be at the higher value and HUD's current initial rate which is higher than it was years ago.
  Basically you would need to visit our HECM refinance calculator and see what your benefits would be above and beyond the amount left in your current line of credit to determine the actual benefit of a refinance under today's HUD parameters.
  Remember, lenders can't even do a refinance unless your loan meets certain conditions such as you are receiving adequate additional funds and it has been at least 18 months since your last loan. In any case, it probably wouldn't hurt to check if you believe you would receive more money under the refinance at this time (a lower interest rate alone is not a large enough benefit in HUD's opinion to lose funds or pay additional costs to refinance).
  Reply to ARLO
James L.
October 15th, 2019

I started out with a reverse mortgage, went to a regular mortgage. Can I go back to a reverse mortgage?
Reply to James
- ARLO™
  October 15th, 2019
  
  Hello James,
  
  As long as you do not have an existing reverse mortgage, you qualify for the loan under the current program parameters (you live in the home, your income and credit qualify and the property still meets HUD's minimum requirements) and your last loan did not result in an unpaid loss to HUD, you can certainly get another loan on this property or another if you move at this time.
  Reply to ARLO
Adrienne
April 9th, 2019

I have a high equity position in my property, will an inside appraisal be needed for a HELOC?
Reply to Adrienne
- ARLO™
  April 9th, 2019
  
  Hello Adrienne,
  
  I can tell you that for a Home Equity Conversion Mortgage or HECM reverse mortgage, the lender would require a full appraisal which would include an inspection of the interior of the property. But because we do not originate HELOC loans, I honestly cannot tell you every bank's requirements for the loans.
  The last several borrower with whom I have spoken who had obtained HELOC loans recently all indicated that they were required to have full appraisals performed of their homes which included interior inspections, but I don't know if that was because of the loan amount, the loan to value or if it is now a policy for all Home Equity Line of Credit loans. I am afraid you would have to speak with the lenders who offer this product to get this information.
  Reply to ARLO
Jason Wheeler
May 11th, 2016

Great blog. I feel like Reverse Mortgages really get a bad wrap by financial planners and consumers. They surely are NOT for everyone but with a really good loan officer like obviously you are, Senior should take a close look at what Reverse Mortgages offer and evaluate the costs based on their retirement goals.

Thanks for the perspective Mike!
Reply to Jason

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