Reverse Mortgage vs. Home Equity Loan: Which Home Equity Option Should You Choose?
By: Review Counsel Staff
October 21, 2024 • 6 minute read
Reverse Mortgage vs. Home Equity Loan: Which Home Equity Option Should You Choose?
One of the advantages of owning a home is that as you pay down your mortgage and the value increases, you grow your equity.
Equity is simply the difference between the value of your home and what you owe. There are several financial products available to homeowners that allow them to tap into that equity.
Two of those options include a reverse mortgage and a home equity loan.
In this article we are going to dive into what each product is, how they work, and how to decide which one may be right for you.
What is a Reverse Mortgage and How Does It Work?
The most common type of reverse mortgage that lenders offer is the Home Equity Conversion Mortgage (HECM).
A reverse mortgage is a loan just like a traditional mortgage, but the requirements and the way it is paid back are very different.
While some requirements may vary from lender to lender, here are the basic requirements of a reverse mortgage that you can expect:
- A HECM reverse mortgage is available to homeowners who are 62 years of age and older. Only one homeowner must be 62 years old to qualify.
- The home must be the primary residence
- The home must be maintained
- The home generally needs to have a minimum of 50% equity
- Homeowners need to be current on property taxes, homeowner’s insurance, and any other costs such as homeowner association (HOA) dues.
In order to qualify, the home must be one of the following:
- A single-family home
- A two-to-four-unit property, in which the owners occupy one of the dwellings.
- A condominium approved by HUD
- Townhouse
- Manufactured homes that were built after June 1976
One of the advantages to a HECM reverse mortgage is that it’s insured by the federal government. This also means that the only lenders that offer them are approved by the Federal Housing Administration (FHA).
The amount of money borrowers receive from a reverse mortgage depends on the age of the youngest homeowner, the interest rates, and the home’s value.
The FHA does have a limit on how much borrowers may receive. As of 2024, the current lending limit is $1,149,825.
A traditional mortgage is paid back with monthly payments. A reverse mortgage is required to be paid back when the homeowner sells the home, the home is no longer the primary residence, or when the last homeowner on the mortgage passes away.
Who is a Reverse Mortgage for?
Given the age requirement of a reverse mortgage, it is designed to be a resource for those who are near or in retirement.
It is not uncommon for those in retirement to find themselves living on a fixed income while having a significant amount of their wealth tied up in their home. A reverse mortgage gives homeowners access to their equity without adding additional monthly payments to what may already be a tight budget.
A reverse mortgage can be used to meet a variety of needs including:
- Home upgrades
- Traveling
- Making a large purchase
- Paying off consumer debt
- Supplementing income
- Saving for a rainy day
What you plan to use the funds for will determine how you decide to receive the funds. For example, if you are planning to do home upgrades, you may opt to receive the money as a lump sum. If you are looking to supplement your income, you may opt to receive the money as monthly payments, and if you want to have money available for unexpected expenses, you may opt to receive the money as a line of credit.
What is a Home Equity Loan and How Does it Work?
A home equity loan is similar to a home equity line of credit (HELOC), as they are both considered to be second mortgages.
A home equity loan is dispersed in a lump sum. By comparison, a HELOC is available as a line of credit.
The home equity loan is then paid back in fixed monthly installments over 5 to 30-year terms. The payments include both principal and interest.
Home equity loans may be taken out on a primary or secondary residence.
The home is used to secure the loan, which also means if you fail to pay the monthly payments, you could risk losing your home. If the loan is not paid off by the time you sell your house, the loan balance will need to be paid back in addition to the original mortgage.
In order to qualify for a home equity loan, these are the typical requirements you can expect:
- Minimum 620 credit score
- More than 20% equity in the home
- Verifiable and consistent income
- Debt-to-income ratio no higher than 43%
Please note that each lender has its own requirements.
Who is a Home Equity Loan for?
A home equity loan may be a good option for homeowners with the following needs:
- They need money fast.
- They have one specific expense such as a home improvement project or a wedding.
- They want to pay off high-interest consumer debt.
- They need seed money to start a business.
There are no restrictions on how the money may be used. However, most experts recommend that the money is not used on frivolous expenses since the home is on the line if the borrower is unable to make the payments.
Which One Should You Choose?
Whether you decide to pursue a reverse mortgage, or a home equity loan will depend on several factors.
Do you meet the qualifications?
A reverse mortgage comes with very specific requirements. If you aren’t at least 62, the property is not your primary residence, and you don’t have significant equity in the home, you won’t be able to qualify for a reverse mortgage.
A home equity loan also comes with several requirements such as having a minimum credit score and income to qualify. If you are more than 62 and you have a poor credit score, then a reverse mortgage may be the way to go.
Do you need the money fast?
If you find yourself in a situation in which you need an infusion of cash fast, then a Home Equity Loan is definitely the faster option. A reverse mortgage typically takes up to 45 days to close. A Home Equity Loan can take from two to six weeks to process.
Do you need a long-term solution?
If you are looking for a solution that may serve as an income source for the long-term, then a reverse mortgage is going to be the better choice.
What if you have bad credit?
A home equity loan comes with credit and income requirements that need to be met in order to be approved. A reverse mortgage does not have income and credit requirements needed for approval. However, a reverse mortgage does require that you are able to maintain the home, pay property taxes, pay homeowners’ insurance, and any other necessary costs.
Next Steps
If you’ve made your decision and you are ready to move forward, the next step is to reach out to a reverse mortgage lender or home equity loan lender to begin the application process.
Check out our list of recommended reverse mortgage lenders.
Check out our list of recommended mortgage lenders.
| Features | Reverse Mortgage | Home Equity Loan |
|---|---|---|
| Funds Disbursement | Lump sum, monthly payments, line or credit or combination of the three | Lump-sum payment |
| Age Requirement | Must be at least 62 years old | No age requirement |
| Equity Requirement | At least 50% equity | More than 20% equity |
| Credit & Income Requirement | No credit or income requirement | Minimum 620 credit score and steady income |
| Repayment | When the home is sold, it is no longer the primary residence, or the homeowner passes away | Monthly payments |
| Residency Requirements | For primary residence only | For primary or secondary residence |
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.
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