Two popular options that enable homeowners to access the equity in their homes are reverse mortgages and home equity loans. Both are financially rewarding, however, you still need to understand how each work. So, reverse Mortgage vs. home equity loan which is better? Continue reading.
What is a Reverse Mortgage?
A reverse mortgage is a form of loan for homeowners who are at least 62 years old can turn part of their home equity into a cash amount.
This is different from the regular mortgage, where homeowners make monthly payments to a lender, with a reverse mortgage, the lender makes payments to the homeowner either as a check, fixed monthly payments, a line of credit, or any combination of the above-mentioned options.
Reverse mortgages are devised to supply the elderly with financial flexibilities by using the equity that they built up in their property over the years without requiring them to sell the property or come out with monthly mortgage payments.
Eligibility Requirements
1. Age: Usually, a homeowner must be at least 62 years old; however, some entities may have a slightly different set of conditions.
2. Homeownership: A borrower should not be a tenant on someone else’s property, and the home equity should be at least 20 percent.
3. Primary Residence: The main house must be the owner’s principal residence, where he lives for most of the year.
4. Financial Assessment: In some cases, a financial assessment may be conducted by the reverse mortgage lender to confirm that the homeowner can afford to pay for the maintenance of the property, property taxes, and homeowners insurance if needed.
How Reverse Mortgages Work
Once a homeowner is approved for a reverse mortgage, they can choose from a variety of ways to receive the funds, such as a single lump sum, monthly payments, a line of credit, or a combination of them.
The amount of money accessible through a reverse mortgage depends on a number of factors, like the age of the homeowner, the current market value of the house, the current interest rate, and the specific terms of the reverse mortgage.
The loan is due when the homeowner sells the house, leaves the home permanently, or dies. At that point, the loan must be repaid, and it is most commonly done through the proceeds from the house sale.
Types of Reverse Mortgages
There are two main types of reverse mortgages:
1. Home Equity Conversion Mortgage (HECM)
HECMs are insured by the Federal Housing Administration (FHA) and are the most common among the reverse mortgage types. They have different types of payments that are under HUD rules.
2. Proprietary Reverse Mortgages
These are private, stand-alone reverse mortgage products offered by private lenders. They may differ regarding eligibility, loan, and payment terms as compared to HECMs.
What’s a Home Equity Loan?
A home equity loan, best known as a second mortgage, is a kind of loan that can be obtained by homeowners to borrow money by using the equity of their home as collateral.
Home equity loans are usually of the fixed-rate kind. Consequently, the interest rate remains unchanged during the whole period of the loan, and borrowers pay monthly installments to repay the loan.
Eligibility Requirements
To qualify for a home equity loan, homeowners must meet certain eligibility criteria such as:
1. Sufficient Equity: This category of borrowers is generally required to have at least 15% to 20% of equity (after you pay off your primary mortgage) in the home.
2. Creditworthiness: The lender carries out a credit score and credit history check to check whether a homeowner will pay the loan on time.
3. Debt-to-Income Ratio: Creditors may as well review the debt-to-income ratio, which is calculated as the homeowner’s monthly debt payments divided by their gross monthly income.
How Home Equity Loans Work
Approval for a home equity loan enables homeowners to receive a lump sum of money, which they could use for different purposes.
The interest rate and monthly payments of a home equity loan are the same, which makes them easy to budget.
Borrowers repay the principal and interest in installments for a term ranging from 5 to 30 years, with the freedom to pay off the loan early without any penalties.
Types of Home Equity Loans
The two main types of home equity loans are:
1. Standard Home Equity Loan
In this type of home equity loan, a borrower receives a lump sum of money at once and then repays the loan in fixed monthly installments throughout the term period.
2. Home Equity Line of Credit (HELOC)
A HELOC is a revolving loan that a homeowner can withdraw from. It’s just like a credit card. Borrowers can use the credit line as needed during a specific draw period, typically between 5 and 10 years, followed by a repayment period in which they repay the amount borrowed plus interest.
Key Differences Between Reverse Mortgage vs. Home Equity Loan
1. Payment Structure
• Reverse Mortgage: As opposed to the typical borrowing from the lender, the homeowner would be receiving payments from the lender.
No monthly payment is required, and the loan balance usually gets larger as interest grows.
• Home Equity Loan: On the other hand, in home equity loans, the homeowner is given a lump sum upfront or a line of credit and is asked to make monthly payments, including principal and interest, to repay the loan.
2. Repayment Requirements
• Reverse Mortgage: A repayment schedule on a reverse mortgage is usually deferred until the homeowner sells the house, permanently leaves the house, or dies. At the loan maturity, the loan is payable, in most cases, from the sale proceeds of the property.
• Home Equity Loan: Home equity loans have a fixed schedule of repayment, and homeowners are obliged to remit a payment every month until the total amount is paid off.
3. Impact on Home Equity
• Reverse Mortgage: The balance of a reverse mortgage increases continually, which in turn starts to reduce the equity that homeowners have in their property. This may affect the amount of inheritance left to the dependents.
• Home Equity Loan: Home equity loans differ from reverse mortgages since they do not consume home equity. The loan amount is fixed, and homeowners are required to pay off the loan over time, keeping and increasing ownership and equity in the property.
4. Qualifications and Eligibility
• Reverse Mortgage: To be eligible for a reverse mortgage, homeowners must be aged 62 or older and have considerable equity in their residential property. Credit score and income restrictions could be more relaxed compared to a typical mortgage.
• Home Equity Loan: There are many factors that determine if you are qualified for a home equity loan: credit score, income, debt-to-income ratio, and home equity. If a homeowner of any age meets the lender’s criteria, he or she is eligible.
Factors to Consider When Deciding Between a Reverse Mortgage vs. Home Equity Loan
1. Long-Term Plans and Objectives
Consider your long-term plans and goals, such as retirement, or leaving an estate for your children.
2. Also, think about the impact of each loan type. Are you are ready to bear the consequences of maybe losing home equity or accumulating interest? The answer lies in your hands.
FAQs
Q. What is the main difference between a reverse mortgage and an equity loan?
A. A reverse mortgage allows homeowners (aged 62 or older) to use the equity of their home without monthly payments; however, a home equity loan involves repayments and is usually accessible to homeowners of any age.
Q. Do either of these options have risks?
A. Among the possible risks of a reverse mortgage are interest compounding over time, possibly reducing the amount of inheritance you will leave to your heirs.
Defaulting on a home equity loan and ultimately losing your home may be the result if you fail to meet the monthly payments.
Read also:Â Loans and Grants: 7 Fast Ways To Own A House In 2024
Conclusion
If you are comparing a reverse mortgage to a home equity loan, take note of your current financial situation.
A reverse mortgage is an option for older homeowners who need their home equity but do not want to pay a monthly payment.
Contrary to that, a home equity loan could be a good choice for those who are looking for a lump sum of cash at a fixed interest rate.
To choose between these options, consider the benefits and drawbacks of each option and seek a mortgage advisor for proper advice.
