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 about Reverse Mortgages
There’s a lot more to be gained by getting a reverse mortgage in 2021. With new product rules in place, as well as longtime, little-known benefits, a reverse mortgage is positioned 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.
With a Reverse Mortgage You Can Also Make Repayments
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.
Reverse Mortgage vs Home Equity Loan Examples
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 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 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 (HECM) 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.
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.
HELOC vs Reverse Mortgage Product Comparison
|Compare Features||Traditional Home Equity Line of Credit (HELOC)||Home Equity Conversion Mortgage (HECM)||Proprietary Reverse Mortgage
|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|
|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|
**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.
HECM 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 at any time the lender chooses. The reverse mortgage is insured and guaranteed to be available under the terms of the loan by HUD and the borrower is not required to make monthly repayments for as long as he/she lives in the home and pay the taxes and insurance in a timely manner.
Which is better Home Equity Line of Credit or Reverse Mortgage?
What is better is what is better for your circumstances. A HELOC is typically less expensive to establish but requires you to make monthly payments and failure to do so can hurt your credit and end in foreclosure. A reverse mortgage allows you to make payments if you want, but none are required and therefore you never have to sorry about months where your income may be less, but it does cost more to establish.
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 were depending on the availability of the funds).
What are the disadvantages of a reverse mortgage line of credit?
The disadvantage of a reverse mortgage is that it costs more to establish and if you want to pass the house down as a large inheritance and do not think you can 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 HELOC’s?
The qualifications are different for HELOC’s and reverse mortgages in that reverse mortgages use a residual income method of qualification vs the HELOC using an ability to repay method. The residual income method looks at all the borrower’s outgoing debts subtracted from their income and the borrower must have a minimum amount left on which to live each month. The ability to repay considers the borrowers debts as a ratio of the borrower’s total income to determine the borrower’s ability to repay the obligation. The residual income method employed by HUD for the reverse mortgage is much easier to qualify for most borrowers, especially those on fixed incomes.
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