Reverse Mortgage vs HELOC: Which is the Best Option for Accessing Equity?

Two popular options for accessing that equity are a reverse mortgage and a Home Equity Line of Credit (HELOC).

But which one is right for you? In this article, we explore these two products, how they work, and scenarios in which one may be a better choice than the other.

Reverse Mortgage Basics

A reverse mortgage is a type of loan that differs significantly from a traditional mortgage.

A Home Equity Conversion Mortgage (HECM), also known as a reverse mortgage, is a loan option designed to help homeowners convert their home equity into cash. When taking out a HECM reverse mortgage, the existing mortgage will be paid off in full, so you no longer need to make regular monthly payments on your original loan.

A reverse mortgage enables homeowners to convert the remaining loan balance into cash. The funds can be received in several ways, such as a lump sum payment, equal monthly payments, or a reverse mortgage line of credit. Alternatively, you can opt for a combination of these options.

A reverse mortgage loan is paid back when the home is sold, when the home is no longer used as the primary residence of the homeowner, or when the last homeowner passes away.

Reverse Mortgage Requirements

In order to qualify for a reverse mortgage, you must meet certain criteria, including the following:

Applicants must be at least 62 years of age or older
The property must be the primary residence. This means that a reverse mortgage cannot be obtained for a secondary property such as a vacation home or investment property.

The home must have significant equity
The property needs to be in good condition

Before homeowners can officially apply for a reverse mortgage, they must first complete a counseling session with an approved counselor from the U.S. Department of Housing and Urban Development (HUD). This counseling session helps to ensure that homeowners understand all the risks and benefits involved with a reverse mortgage and can make an informed decision.

After the reverse mortgage loan closes and you start receiving your funds, reverse mortgage borrowers must continue to maintain the home, pay the necessary property taxes, homeowners insurance, and any other required fees, such as HOA fees.

Learn more about the reverse mortgage requirements by checking out this FREE reverse mortgage information kit.

Reasons to Choose a Reverse Mortgage

One of the reasons a reverse mortgage is such an attractive option is the flexibility it offers.

Unlike other financial products, there is not a single way to receive funds from a reverse mortgage. Instead, various options are available, such as a lump sum, monthly installments, or a HECM line of credit. These options can also be combined to better meet your unique needs.

There are also no rules about how reverse mortgage proceeds have to be used. However, here are some common ways a reverse mortgage is used:

In Your Retirement Portfolio. If you’re nearing or already in retirement and lack the necessary savings to maintain your desired lifestyle but happen to own your home, a reverse mortgage may be worth considering as part of your retirement portfolio.

Unplanned Expenses. If you don’t have adequate funds for emergency expenses, you may consider taking out a reverse mortgage and receiving the proceeds as a line of credit. This will ensure that your funds are available should an unexpected expense arise.
Supplement a Fixed Income. If you are living on a fixed income, then a reverse mortgage can provide additional monthly income. With a reverse mortgage loan, you have the option of choosing to receive the funds in the form of monthly payments, which can help make ends meet.
Upgrade Your Home. If you don’t have the savings to cover the costs of major renovations to your home in retirement, a reverse mortgage could help you make them. Furthermore, these upgrades can potentially increase the value of your home. Receiving a lump sum from a reverse mortgage could provide much-needed financial assistance for such projects.
Travel. If you’ve taken care of all your monthly expenses, updated your home to create a comfortable living environment, and saved up an emergency fund, you can use the extra funds from a reverse mortgage to travel more often and visit friends and family.
Purchase a New Home. While a reverse mortgage is a popular option for those who want to retire in place, it can also be used to purchase a new home. This may be ideal for those who are looking to upsize or downsize or simply want to move to be closer to family. This is known as a reverse mortgage for purchase. It works by combining a large down payment from the sale of a previous home with a reverse mortgage. The advantage of pursuing this option is that older homeowners can relocate without the burden of monthly mortgage payments.

If you’re considering a reverse mortgage, it’s important to be aware that obtaining a reverse mortgage can be a lengthy process. Therefore, if you decide this is an option you want to pursue, it may be prudent to move forward as soon as possible.

If you decide that a reverse mortgage isn’t the right choice for you, you can cancel your loan at any time — even up to three days after closing.

What is a Home Equity Line of Credit?

A Home Equity Line of Credit (HELOC) is a like a home equity loan that works more like a credit card. Borrowers can access funds up to a predetermined limit and pay them back with interest. Funds can be repaid and borrowed multiple times from the same account.

A HELOC is a second mortgage, and your home is used as collateral for the funds. It’s important to be aware that if payments are not kept up, the property could be foreclosed on.

HELOCs typically come with a variable interest rate. The credit limit that a homeowner is eligible for depends on the amount of equity they have in their home. However, lenders can vary in how much they are willing to loan out. The amount of money that can be borrowed is set by the lender and will usually vary from 50-80% of the appraised value.

HELOC borrowers can access the funds allocated to them using a credit card or checks linked to their HELOC account. In most circumstances, the draw period of a HELOC lasts for 10 years.

Homeowners are responsible for making monthly interest payments on the money borrowed from the HELOC. Interest is only incurred on the funds that are used.

After the 10-year draw period is complete, borrowers must begin repaying the outstanding balance. Typically, this repayment period lasts for 10 to 20 years, but homeowners may also start repaying the principal balance before the full 10-year draw period is over.

A HELOC is a flexible and convenient borrowing option that can be used for a variety of purposes, such as paying for home improvements, paying off debt, paying for college, or paying for unplanned expenses.

HELOC Requirements: How You Qualify

A HELOC is more accessible than a reverse mortgage since it does not have an age requirement. However, homeowners must still meet certain qualifications in order to qualify for this type of loan.

The exact requirements and terms can differ between lenders. However, here are the minimum requirements you will likely need to meet:

Equity. A HELOC typically requires a minimum of 15% equity in the home, though 20% is preferred. This value will be determined through an appraisal during the application process. Ensuring sufficient equity is important to establishing the amount available for a HELOC loan.
Debt-to-Income Ratio. A HELOC typically requires a debt-to-income ratio of 50% or less. This ratio is calculated by adding together your total monthly debt payments, then dividing that amount by your monthly income.
Credit Score. To qualify for the best HELOC rates, it is recommended to have a credit score of 720 or more. A minimum credit score of 620 may still be accepted, but higher scores will likely result in better terms and conditions.
Payment History. Having a track record of timely payments can raise your chances of being approved for a HELOC.

Reasons to Choose a HELOC

A HELOC is an ideal option for homeowners who require financial flexibility over a specified period and can make timely interest payments.

It is an excellent choice for homeowners who anticipate needing to make multiple withdrawals over time to cover a range of projects or expenses. Its flexibility makes it well suited to those who aren’t sure how much they will need in order to reach their goals.

A HELOC will also be a better choice for those looking to tap into the equity on a vacation home or investment property where they don’t live full-time since these types of properties do not qualify for a reverse mortgage.

Home equity lines of credit also tend to come with lower interest rates when compared to reverse mortgages.

However, borrowers must also consider their ability to repay the HELOC once the draw period has ended.

How to Decide Between a Reverse Mortgage and a HELOC

There are several factors to consider when deciding whether a reverse mortgage or a HELOC is a better option, including the following:

Age. Reverse mortgages are available to older homeowners and can be an option if you have significant equity in your home. A HELOC is available to homeowners regardless of age.
Financial Goals. Consider why you need the funds. A reverse mortgage may be suitable for long-term income supplementation in retirement, while a HELOC might be better for short-term financial needs or specific projects.
Repayment Ability. If you can manage monthly payments, a HELOC might be more appropriate. If you want to eliminate monthly payments, a reverse mortgage could be a better fit.

Future Plans. If you plan to stay in your home for the foreseeable future, a reverse mortgage might be more appealing. If you anticipate moving or selling your home in the near future, a HELOC may be more advantageous.
Reverse Mortgage Line of Credit Compared to HELOC. If you qualify for both a reverse mortgage and a HELOC, there are two key differences that may help with your decision. First, the reverse mortgage line of credit will never require monthly payments to pay it back. Second, while both options only accrue interest on the money received, if you have a reverse mortgage, the unused balance on the line of credit will grow.

Ultimately, the decision should be based on a thorough assessment of your financial situation, personal needs, and personal goals. It is always recommended to discuss your options with a financial advisor and family members who may be affected by your decision.

Want to learn more about how a reverse mortgage works? Grab our free reverse mortgage guide here.

Want to talk to a reverse mortgage specialist in your area? Find a reverse mortgage advisor here.

Reverse Mortgage vs. Selling Your Home: How to Choose?

Is a Reverse Mortgage a Good Idea?

Record Inflation is Taking Aim at Retirement Plans as Retirees Explore Options

Reverse mortgage borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees.

This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.