What Are Reverse Mortgages vs. Home Equity Loans?
Reverse Mortgages vs Home Equity Loans
Both home equity loans and reverse mortgage loans help home owners cash out some of the equity in their home. They are different products though, and each would appeal to a different type of borrower.
What Is Home Equity?
By equity, we simply mean the difference between the amount you owe on your home and the home value. For example, if you sell your home for $250,000, and you still have to pay off $50,000 because of a prior loan balance and closing costs, your equity would be $200,000. That is the amount you get to pocket.
Until you actually sell your home, you can never get a perfect answer to the equity question, so a professional home appraiser would estimate your home’s value. They examine your home’s size, features, and condition. Then they compare that to other homes in your area that have recently sold.
Home Equity Loan
This type of secured loan is based on your existing home equity. Sometimes it is also called a “second mortgage”. You are basically borrowing (possibly again) against any home equity you have free and clear of a first mortgage.
Some people borrow a fixed amount. Others establish a home equity line of credit that can be used for emergencies down the road. The interest will usually be lower than unsecured credit like credit cards. Sometimes, the interest is tax deductible just like a first mortgage.
The part of your home that is paid off will be collateral against the loan. However, you usually need reasonably good credit to qualify. Understand that failure to make timely payments on this 2nd mortgage could put your home ownership at risk. Your home could be foreclosed upon.
In general, a borrower would seek a home equity loan that they intend to pay off and continue living in their home, or pay off when they sell the home. Loan repayments usually start right away.
Reverse Mortgages
A reverse mortgage also helps you cash in some of the equity. It is a product used by older people in order to use that equity to supplement their incomes. The cash from the transaction should be tax free, but it could limit your ability to qualify for some government based programs like Medicaid.
The borrower can continue living in their home, but does not have to start making monthly payments right away. The loan must be repaid when the borrower leaves the home.
In general, these loans are underwritten based upon the home value, age of the borrower(s), and the interest rate. So the borrowers income and credit ratings will not have a big affect on the loan. In addition, the borrowers must be sixty-two years of age or older. These loans are intended for older people who do have substantial home equity, but who need more income or cash.
You will want to do careful research before you decide if reverse mortgages are good for you.
You Might Consider Home Equity Loans if…..
- You have good credit and a good income.
- You are younger than 62 years old.
- You may not stay in your home much longer.
- You intend to pay the loan of quickly or the loan will not be that large.
You Might Consider Reverse Mortgages if….
- You are old enough.
- You plan to stay in your primary residence as long as you can.
- You need to supplement your income (i.e. social security) and do not want to start making monthly payments.
- You accept that the loan must be repaid, plus closing costs, probably by selling the home, as soon as you move out.
Reverse mortgages can come with high fees and closing costs, and these all reduce the value of the cash you can get for your loan amount. On the other hand, it may be harder for retired people with fixed incomes to qualify for a home equity loan.
Either debt will reduce the value of your home and, possibly, the amount you can leave to heirs. With either loan, you are still the home owner. You are responsible for insurance, repairs, taxes, and possibly, PMI.
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