You have a few options when you need to tap into the equity in your home. Home improvements, debt consolidation, or significant life expenses tend to squeeze finances enough that many homeowners consider their options.
Home equity loans, reverse mortgages, and HELOCs each offer access to cash. However, each loan has its benefits and drawbacks. Let’s explore the pros and cons of each and the requirements to help you make an informed decision regarding your financial future.
If you are a homeowner and are at least 62 years old, you have the option to apply for a reverse mortgage and take advantage of your equity. A reverse mortgage is an excellent way to turn your home equity into cash or a lump sum that you can use to help pay for living expenses, such as:
While you’re probably more familiar with a traditional mortgage, a reverse mortgage isn’t exactly the opposite. Instead of borrowing money to purchase a home that is paid back in monthly installments over 20 or 30 years, a reverse mortgage allows you to receive equity upfront.
Here’s how it works?
Instead of you paying monthly installments to your lender, the lender pays you based on your home’s value. This increases your debt owed while lowering your home equity over time as your lender purchases more and more of your home’s value.
During the entire process, you hold onto the title of your home, but there are a few ways this option can put you in hot water. The loan becomes due in full if any of the following occur:
Suppose these events happen. In that case, the lender sells the home to recover the money. Any equity left of the house goes to you or your heirs in the event of a passing.
If you are considering getting a reverse mortgage, scrutinize every aspect of the fine print. You might even consider having a lawyer review your contracts to avoid any negative happenings. Many predatory lending agencies take advantage of older homeowners with reverse mortgages.
There are other negative drawbacks to going this route. For example, anyone you wish to leave your house to in your will may not inherit the house due to the inability to afford to pay off the loan. Still, reverse mortgages have become more popular in recent years and with the increase in living expenses seniors find this type of loan convenient. Reasons for getting a reverse mortgage vary among individual needs.
A home equity loan, commonly referred to as a second mortgage, is another way to get cash from your home equity. Like the reverse mortgage, you are given a lump sum of money you can use for finances.
Still, unlike a reverse mortgage, there is no minimum age to apply. However, it would help if you had at least 20% equity to apply for a second mortgage. You also need to have a good credit history to ensure your lender that you can take on the extra payments every month.
Just like your initial first mortgage, you receive your money and pay it back over a more extended period of time with regular payments until you pay off the principal and the interest. Most of the time, these are at a fixed rate, so your costs remain the same amount throughout the entire process.
Home equity loans are a popular way to finance the costs associated with sending kids to college, consolidating debt, or taking on major renovations. There are many other reasons why people select to take a home equity loan.
These loans require monthly payments similar to your original mortgage. If that’s a debt you’ve been free from for a while, you’ll have to adjust to afford the long-term commitment. A reverse mortgage might be a better option if you’re retired and living on a fixed income.
A home equity line of credit, or HELOC, works more like a secured credit card than a mortgage, meaning that equity is given to you on an as-needed basis. Instead of receiving one lump sum of money like a reverse or second mortgage, your home equity is paid out when you need it.
It is commonly compared to a credit card, and in many cases, you are given a debit card tethered to your HELOC to use when you need it.
HELOC is widely used for home improvement projects. When you choose a HELOC option, it is still considered a second mortgage. Still, because it is structured differently, it is not widely considered to be such.
This type of loan is perfect when you aren’t entirely sure of the total amount you need. You are in complete control of how little or much you use with a HELOC loan, and it usually takes less time to pay off.
Like a traditional second mortgage, there is no age limit required like the reverse mortgage. It is best to show your lender that you can handle the extra expenses. This includes calculating your credit history and debt-to-income ratio (DTI) to determine your creditworthiness.
Keep in mind that a home equity line of credit may come with ongoing maintenance fees or variable interest rates.
Any respectable and trustworthy financial institution will gladly help you with your financial needs. Every place you look into will have different rates and terms, so shop for the best option.
This is also a great way to have any of your specific questions answered about the whole process and go into greater detail with a knowledgeable professional.
Repayments
In order to make accurate payments, you need to ensure you have the correct information. You won’t want to fall behind or incur penalties for inaccurate payments. Suppose your lending agent has a helpful app you can take advantage of. In that case, it is highly recommended that you utilize such a tool and set up auto payments if that option is available.
Repaying a loan can depend on several different terms, and repayment can start depending on the type of loan.
For example, several things can trigger immediate repayment in a reverse home mortgage. These include delinquent taxes, decaying property, or vacancy from the residence.
However, the facts are more upfront when it comes to a home equity loan. The terms of this type of loan are laid out from the beginning regarding repayment schedule, amount and length, and interest factors too.
Still, with a HELOC option, your monthly repayment can vary. Your monthly payments are interest only during the draw portion of the loan and then increase during reimbursement periods.
Tax Advantages
Tax advantage only applies to the home equity loan and the HELOC options because the reverse mortgage doesn’t really have any tax advantages until the loan is terminated.
If you took out a home equity loan or HELOC between 2018 and 2025, you might take advantage of some tax breaks. Suppose the proceeds of these types of loans were used to significantly improve your home or were used to build or purchase a home. In that case, you can have an interest-only tax deduction taken care of.
It’s not a one size fits all situation, and homework needs to be done on your part to determine your best fit. Everyone’s needs are different, and you need to do your due diligence and make the decision that you feel is best for you and your household.
When it comes to choosing the right type of loan, consider your goals and the circumstances of your life.
You can weigh these factors against the outlook of your likely future and repayment terms to help you decide which type of loan to apply for. Creating a pros and cons list may also help you gain clarity.
At Promise Home loans, we will give you all the options available. You can apply online or talk to us directly. Let us know how we can help you.
Photo credit: MonthiraYodtiwong
