This article does not constitute tax or financial advice. Please consult a tax and/or financial advisor regarding your specific situation.
Retirement is a time to maximize your savings and your quality of life — and tapping the equity in your home is a way to achieve both goals.
Although you may get a lot of use and enjoyment from your home, you may not see it for the asset that it is. And the hard-earned equity that you’ve built up over the years could help you achieve your financial goals and while enjoying more security and opportunities in your retirement.
Deciding how to use that equity generally comes down to one question: do you take out a home equity loan, line of credit, or a reverse mortgage?
We’ll explore these different options and how they fit into a larger financial plan — and help you figure out whether a reverse mortgage vs home equity loan is right for you.
What is a reverse mortgage?
A reverse mortgage is a loan secured by your home that has an optional monthly payment. Unlike “forward” mortgages, in which you make monthly payments toward your principal and interest, a reverse mortgage allows you to take money out of the home without worrying about a monthly mortgage bill.
Reverse mortgages come due when the last borrower or non-borrowing spouse passes away or moves out of the home. Until then, borrowers can access money from the home in the form of a line of credit, a lump sum payment, or monthly installments.
There are different types of reverse mortgages, but the most common one is a Home Equity Conversion Mortgage (HECM). The Federal Housing Administration (FHA) — under the U.S. Department of Housing and Urban Development (HUD) — insures this loan.
Reverse mortgages can be a way to supplement retirement income with additional cash payments and even delay making withdrawals from your retirement investment accounts. You can use reverse mortgage funds however you choose. This may include to renovating your home, covering healthcare costs, travelling, or simply giving yourself a more comfortable buffer for lifestyle expenses each month.
What if I want my kids to inherit my house?
Homeowners are sometimes reluctant to take out a reverse mortgage because they worry about what will happen to the home when they die. If the homeowners’ children inherit the house, they will need to pay off the reverse mortgage balance in one of a few ways:
- Sell the home
- Refinance to a traditional “forward” mortgage
- Pay off the mortgage with their own funds
A reverse mortgage is just like any other loan. It does not grant ownership of the home to the government when you die or move. The balance simply needs to be paid off.
If you want your children to inherit your house, you might worry about jeopardizing that option for them. But statistically, children rarely move into the house they inherit from their parents.
Many retirees choose to continue paying their mortgage. But that might mean limiting their monthly cash flow and their ability to travel, visit grandkids, and take vacations. A reverse mortgage could free up funds that give them more control over how they spend their retirement years.
Of course, if you are concerned about property inheritance, it’s a good idea to talk about the options with your children. Maybe they plan to keep the house in the family, in which case they’ll need a strategy for how to pay the reverse mortgage when the time comes.
But if keeping the home in the family is not a priority, a reverse mortgage may be the right choice for increasing your monthly cash flow and planning for your changing health and lifestyle needs.
Reverse mortgage basics: How do reverse mortgages work?
When you take out a reverse mortgage, you are borrowing against the equity in your home. But you keep the title to your home, and you are not obligated to make a monthly mortgage payment.
However, you must continue paying property taxes, homeowners insurance, and any homeowners association fees. You’re also obligated to maintain the property and keep up with repairs and standard wear and tear. If you fall behind on your taxes and insurance, the lender can call in the reverse mortgage and you could owe the full balance before you’ve left the home.
You can receive your reverse mortgage funds in several ways:
- A lump sum payment
- A line of credit
- Monthly cash advances
- A combination of monthly advances and a line of credit
|Learn more about these options by checking out our reverse mortgage guide.|
Another benefit of a reverse mortgage is that the funds you receive from the loan do not count as taxable income. That means they won’t count against you when your Social Security and Medicare benefits are calculated.
Reverse mortgage approvals do not have income limits or requirements. However, your lender will evaluate your finances to determine whether you can keep up with taxes, insurance, and other costs associated with homeownership.
A reverse mortgage is a non-recourse loan, which means you or your heirs can never owe more than the value of your home when the loan becomes due.
Although reverse mortgages have an optional monthly payment, some borrowers choose to continue making their monthly installments, particularly if they are still working. The reverse loan affords them flexibility, but making payments may increase your line of credit and the amount of funds you can access later on in retirement.
Who qualifies for a reverse mortgage?
You must be at least 62 years old to be eligible for a reverse mortgage and your home must be your primary residence. Once the borrower(s) passes away or moves out of their home, the loan becomes due. In some cases, your spouse may be able to stay in the home after your passing.
If you plan to take out a reverse mortgage with your spouse, they must be at least 62 as well. Spouses who are not yet 62 may be listed on the loan as a non-borrowing spouse. Doing so can make it easier for them to stay in the home if the borrower passes away or moves into assisted living or a healthcare facility.
Other reverse mortgage eligibility requirements:
- Borrowers cannot be delinquent on any federal debt
- Before closing on the loan, borrowers must participate in a consumer information session given by a HUD-approved HECM counselor
- Eligible property types must meet all FHA property standards: single-family homes, multifamily homes with a maximum of four units, condos, and manufactured homes are acceptable
Borrowers must have equity in the home to qualify for a reverse mortgage, but you do not have to own the home outright. The reverse mortgage replaces the existing loan, plus gives you additional funds if there’s enough remaining equity.
The interest accrued on a reverse mortgage is not tax-deductible until you’ve paid on it, which may not be until the loan is paid off if you choose not to make monthly payments.
What is a home equity loan or line of credit?
A home equity loan or home equity line of credit (HELOC) is another loan product based on your home’s equity. Either of these products could be an alternative to a reverse mortgage, as the funds may also be used for any purpose, including renovations, travel, to consolidate debt, or fund your children’s education costs.
Payments on a home equity loan or line of credit are not deferred, unlike reverse mortgages. So, you will owe on them each month.
Home equity loan
A home equity loan, often called a second mortgage, is guaranteed by the equity in your home. Like a traditional mortgage, this loan requires underwriting that verifies your financial standing, credit history, and the market value of the house, which will be used as collateral for the loan.
Home equity loans typically have a fixed interest rate, and the loan proceeds are paid out as a lump sum.
Home equity line of credit (HELOC)
A home equity line of credit, or HELOC, is similar to a home equity loan in that it is secured against your home. But instead of a lump sum payment, you receive a revolving line of credit to draw on as needed.
With the line of credit, you only make payments on the amount of credit you are using. For instance, if you’ve got a $100,000 line of credit but only use $15,000, that’s the amount you’ll make payments on. HELOCs typically have variable interest rates.
You make payments on a home equity loan or HELOC on a monthly basis, beginning immediately after you take out the loan.
Reverse mortgages have a leg up on HELOCs and home equity loans for this reason: the optional payment means more cash in the bank rather than tied up in loan installments.
Proceed with caution
When you take out a home equity loan or HELOC, they are secured by your home and you make payments on them in addition to your mortgage. If you fall behind on any of these payments, you could put your house at risk of foreclosure.
Although a reverse mortgage is also secured by your home, you don’t have to make a monthly payment. The balance of the loan isn’t due until you leave the home or pass away, at which point the home can be listed for sale. As long as you keep up with your taxes, insurance, and maintenance, you are less likely to be at risk of losing the home while you’re living in it.
Reverse mortgage vs home equity loan vs HELOC
|Reverse Mortgage||Home equity loan||HELOC|
|Age||62||No age requirement||No age requirement|
|Property requirement||Primary residence||Any eligible property||Any eligible property|
|Repayment options||Optional monthly payment; loan balance comes due when last borrower leaves the home||Fixed monthly payments||Monthly payments based on amount of credit used|
|Length of loan||Dependent on borrower lifespan or occupancy status||Fixed-term||Variable based on credit usage|
|Tax advantages||Due at loan payment (upon death or moving out)||Interest may be tax-deductible||Interest may be tax-deductible|
Reverse mortgage vs home equity loan: Which is better?
Now that you know a little bit more about reverse mortgages and home equity loans and HELOCs, you might wonder which one is the best. But the answer depends on your personal financial circumstances.
Let’s see reverse mortgage vs home equity loan head-to-head.
When you may want to use a reverse mortgage
It’s worth considering a reverse mortgage if you:
- Meet the age and equity requirements
- Need additional cash flow for medical costs or lifestyle expenses
- To eliminate your monthly mortgage payment to improve cash flow
- Understand that your heirs will need to sell the home or pay off the loan balance after you pass away or leave the home
When you might choose a home equity loan or HELOC
A home equity loan or HELOC is worth considering if you:
- Don’t qualify for a reverse mortgage due to your age or amount of equity
- Would like to pay down your home loan balance and leave your home or home’s equity to your heirs
- Have sufficient income to make your first mortgage payment and a second payment on the home equity loan or HELOC
- Want to tap the equity on a property that is not your primary residence
Deciding on the best way to leverage your home equity is a big decision. It’s not one you have to — or should — make alone. A mortgage lender can talk you through the reverse mortgage option and help you compare it to a home equity loan or line of credit.
You’ll also want to discuss your plans with a trusted financial advisor and perhaps with your children or designated heirs. It’s important to get clear on your needs, your family’s goals, and the best strategies for maximizing your assets in retirement.
Reverse mortgage vs home equity loan FAQs
The best loan product will be one that fits your personal financial circumstances. You should speak with a trusted financial advisor to know more about how a reverse mortgage or home equity loan would fit within your estate plan. A reverse mortgage can eliminate your monthly payment, and maybe give you additional cash as well. A HELOC does not eliminate your payment. In fact, it increases it. So examine your monthly budget and cash flow to determine which option is best for you.
A reverse mortgage is similar to a home equity loan in that your home serves as collateral for the loan. However, a reverse mortgage does not need to be repaid until you die or move out of the home, and you or your heirs are not obligated to make payments on the principal or interest until that time. With a home equity loan, you will be required to make monthly payments immediately after receiving the funds.
A reverse mortgage can be a substantial asset to your retirement plans since the funds you receive from it do not count as taxable income. You also don’t have a monthly payment obligation, as the loan comes due when the last borrower dies or moves out.
However, if you plan to leave the home to your children, they will need to pay off or refinance the reverse mortgage when they inherit the house. Otherwise, they will need to sell the home to pay off the loan.
Although you don’t have to make a monthly payment, you must continue paying your property taxes, homeowners insurance, and any homeowners association fees. You must also continue to pay for maintenance and upkeep on the property.
Explore your options
Using the equity in your home to accomplish your financial objectives can be a smart and lucrative move — provided you have a plan for how to use the funds effectively and how you’ll handle repayment.
Talk to a lender about which home equity products are an option for you and how you can use your home to boost your retirement and take care of your family.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency. Reverse mortgage borrowers are required to obtain an eligibility certificate by receiving counseling sessions with a HUD-approved agency. The youngest borrower must be at least 62 years old. Monthly reverse mortgage advances may affect eligibility for some other programs. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.