[Disclaimer]

For reverse mortgage loans:

The borrower must meet all loan obligations, including living in the property as the principal residence and paying property charges, including property taxes, fees, hazard insurance. The borrower must maintain the home. If the homeowner does not meet these loan obligations, then the loan will need to be repaid.

Home Equity Loan vs. Reverse Mortgage

If you’re looking for a way to tap into your home equity, you may have come across these two options. Home equity loans and reverse mortgages both use the home as collateral, but they function very differently.

In this article, we’ll focus on home equity loans with a lump sum payout (as opposed to a home equity line of credit). Let’s review how each option works and what to consider when deciding between a home equity loan and a reverse mortgage.

How a home equity loan works

A home equity loan is a type of second mortgage that allows people to borrow money against the equity they’ve built up in their homes. Each lender may have its own eligibility requirements. At minimum, most borrowers will need to meet credit, equity, and income standards to be eligible for a home equity loan.

While many lenders prefer borrowers with credit scores above 670, some may accept scores below this number. Like most loans, borrowers with higher credit scores could be eligible for more favorable rates.

One possible advantage of a home equity loan is that it’s uncommon, though still possible, for the lender to require mortgage insurance. This could be an important consideration when discussing loan costs and terms with the lender.

Borrowers who take a home equity loan with a lump sum cash payout are required to repay the loan in fixed monthly installments over a set period. The interest rate is typically fixed. The maximum amount is based on the home’s loan-to-value ratio, but the actual amount available to the borrower is determined by their equity and the lender’s policies.

What is the loan-to-value ratio?

The loan-to-value (LTV) ratio compares the amount the borrower is financing to the appraised value of the property. LTV is calculated by dividing the loan amount by the appraised property value and multiplying by 100 to determine a percentage.

Hypothetical example: If you borrow $70,000 on a home valued at $100,000, your LTV is 70%.

How a reverse mortgage is different

Unlike a home equity loan, a reverse mortgage doesn’t require a new monthly mortgage loan payment. There are reverse mortgage loan options with both fixed and variable interest rates. Interest accrues on the balance, but the loan does not become due and payable unless the borrower no longer uses the home as their primary residence, passes away, or fails to uphold the loan terms.

Other key things to know about reverse mortgages include:

• Age requirements: Home Equity Conversion Mortgages (HECMs) are available to those aged 62+. Proprietary reverse mortgages may have different age rules.
• Non-recourse loan: This means that neither you nor your estate will owe more than the value of your home when the loan becomes due and the home is sold. If you default on the loan or if the loan cannot otherwise be repaid, the lender cannot look to your other assets (or your estate’s assets) to meet the outstanding balance on your loan.
• Financial assessment: While there is no strict minimum credit score or income requirement for a HECM, applicants must undergo a financial assessment that considers factors including their credit history, income, and ability to keep up with property charges. In some cases, borrowers may be required to set aside funds to cover taxes and insurance.

Inheritance considerations

Many borrowers, especially those in or near retirement, want to understand how these loans affect inheritance.

With a reverse mortgage, the full balance including interest must be repaid when the loan becomes due. This could be done by selling the home. Heirs can also choose to repay the loan through other means. Because reverse mortgages are non-recourse loans, heirs won’t owe more than the home is worth.

In contrast, a home equity loan is not non-recourse. The estate is responsible for the entire remaining balance if the borrower passes away before repaying the loan. Heirs may choose to sell the home, refinance, or use other assets to settle the debt.

Comparing home equity loans and reverse mortgages

Let’s break down these loan options with a simple comparison.

	Home Equity Loan	Reverse Mortgage
Age requirements	18+	62+ for HECM; may vary for proprietary loans
Income requirements	Sufficient to support the monthly mortgage payment and related expenses required by the terms of the loan	No set minimum, but borrowers must have the ability to cover ongoing property expenses
Credit score	Typically, 670 minimum, though lower scores may be accepted; borrowers with higher scores may be eligible for better terms	No set minimum for a HECM; eligibility based on financial assessment
Monthly mortgage payments	Required; calculated based on the loan amount, interest rate, and term of the loan	Not required as long as the borrower continues to meet all loan obligations
Interest rate	Usually fixed	Fixed or variable, depending on the terms of the loan
Non-recourse loan	No	Yes

Which loan is right for you?

If you’re eligible for both types of loans, consider the following:

• Cash flow: Can you afford to add a new monthly payment?
• Estate plan: Have you and your heirs discussed how the loan could affect estate planning?
• Use of funds: Is this a one-time need, or do you need flexibility for the future?
• Long-term planning: How could these options fit as part of your retirement strategy?

As with any major financial decision, it’s best to speak with a qualified financial advisor who can walk you through the pros and cons of each option.

[Disclaimers]

This article is intended for general informational and educational purposes only and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.