Seniors looking to tap into their home equity have a few different options available in the marketplace today.
These choices include a reverse mortgage as well as a home equity line of credit (HELOC). Both options allow borrowers to access the equity in their homes, but have different features and requirements in order to obtain the loans.
Similar to any other mortgage product, both options require the borrower to pay the loan back and meet the ongoing obligations of the loan. These include paying any taxes and insurance that is required on your home and ensuring the property remains in good condition.
A reverse mortgage is a loan that allows borrowers who are 62 years and older to access a portion of equity from their home.
The most popular reverse mortgage product available is the Home Equity Conversion Mortgage (HECM). The amount borrowers are able to access depends on the age of the borrower, current interest rates, amount of equity, and the lesser of the home value, sale price or the maximum lending limit.
One of the major benefits of the HECM is that it is insured by the Federal Housing Administration (FHA) and as a result, includes several features to protect the borrower and make sure he or she has access to the equity in the home.
A popular feature of the HECM product is that borrowers are not required to make monthly mortgage payments as long as they occupy the house as their primary residence. They are required to pay back the loan when they move out of the home or pass away.
The insurance does a few things: It ensures that the funds will always be available, even if a lender goes out of business, and gives borrowers the assurance they and their heirs can never owe more on the loan than the home is worth at the time of sale.
Depending on the type of program—fixed rate or adjustable rate—borrowers can receive the funds from the loan through monthly, term or tenure payments, a line of credit or they can choose to withdraw all of the funds at once.
Another feature of the reverse mortgage is that it generally does not have any credit requirements in order to qualify.
In order to obtain the loan, borrowers are required to receive counseling from an approved Department of Housing and Urban Development agency. During the session, a trained counselor will review the details of the loan and can answer any questions the borrower has about reverse mortgages and their obligations.
A Home Equity Line of Credit (HELOC) also allows borrowers to access a certain amount of their home equity. After the loan is taken, borrowers can withdraw any funds available during the draw period.
To obtain a HELOC, borrowers will be required to meet certain income and credit qualifications to ensure they can repay the loan. Unlike the reverse mortgage, borrowers must make monthly payments to repay the loan.
Depending on the lender, borrowers may be able to obtain either a fixed or adjustable rate HELOC, but the majority of these loans are adjustable and are tied to a prime rate.
Both products allow borrowers to access the equity in their home, but a reverse mortgage typically has less restrictive requirements for seniors on a fixed income.
Reverse mortgages have potential downsides as well. Typically the upfront fees are higher, for example the mortgage insurance that is paid to the FHA. The HECM product is also a negative amortizing loan, which means the loan balance grows over time.
While a HELOC does not include any additional insurance fees, it also does not provide the same protections. If the value of a borrower’s home has fallen significantly, the bank has the ability to cut off or freeze any remaining line of credit.
Additionally, with a HELOC if the borrower decides to sell the home and owes more than the home is worth, the bank may require that the borrower make up the difference as well.
Because borrowers are required to pay mortgage insurance on HECM loans, they can rest assured that they and their heirs will never owe more than the home is worth and that lenders cannot freeze or cut off access to their funds.