As you approach retirement, you may find yourself in need of cash to deal with certain expenses. Perhaps you have decided to address a long-delayed home remodeling, you want to travel, or you just need extra living expenses for a given period.
There are several ways for you to use the equity in your home to acquire cash for these expenses. One is a home equity loan (or a version known as a home equity line of credit, or HELOC). The other is a reverse mortgage. You have probably seen advertisements for both and are wondering which one is right for you.
Here is a simplistic way to think of the difference: a HELOC is essentially a second mortgage secured against the equity in your home, and a reverse mortgage is essentially the slow process of selling your home back to a lender.
They are working in opposite directions, if you will. HELOC’s are typical loans where you pay back the lender to clear your debt and the accrued interest. With reverse mortgages, the lender pays you regularly in exchange for part of the equity in your home. Should you or your heirs want the home back, you will need to pay off the loan balance on the reverse plus the accrued interest.
Standard home equity loans are fixed-rate and interest is paid on the full amount borrowed. HELOC’s are generally variable rate, and you are allowed to borrow up to a certain limit. You pay interest on whatever amount you borrow.
Consider the following differences in the two methods:
- Requirements – For a HELOC, you need at least 20% equity in the home and must meet typical loan obligations for credit score, stable income, and overall debt load. Reverse mortgages are only available to people age 62 or older, with at least 80% equity in the home and some verifiable modest income to cover annual insurance and taxes.
- Timeframe – HELOCs are based on a set term with a draw period and an extended time for repayment, typically something like a 20-year total term with the first 10 years as a draw period. Reverse mortgages may be for a fixed term or open-ended (in effect until you move or pass away).
- Payments – HELOC payments are standard monthly payments based on the amount borrowed and the current interest rate. You make regular interest payments but borrow and pay off the principal at various times during your term. Reverse mortgages are payable in full at the end of the terms as listed above.
- Tax Concerns – Reverse mortgages provide no tax advantages, and the deduction for interest on HELOCs has been eliminated by the Tax Cuts and Jobs Acts of 2017.
- Fees – Reverse mortgages typically have higher fees and closing costs compared to HELOCs. Do not forget to consider this when doing a cost/benefit analysis.
HELOCs lend themselves more to short-term projects and simpler situations, whereas reverse mortgages are geared more toward living expenses and running cash flow needs where you do not intend to pass your home to your heirs.
However, there are important issues to consider with reverse mortgages. You may outlive the equity in your home, and you must maintain the home and take care of all expenses such as property taxes and insurance. Failure to do these could mean the loss of your home. If you should eventually require long-term care outside the home, you would violate the residency requirement and bring the loan due immediately.
Spouses should also be co-borrowers in the reverse mortgage. Borrowing in only one spouse’s name presents the risk of the surviving spouse being required to pay off the reverse mortgage in full or risking eviction.
Be sure to investigate your options in greater detail, and do not be afraid to seek expert advice. With due diligence, you will make the right decision and acquire the cash you need with confidence.
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