You’re retired and you need cash. It’s reverse mortgage vs HELOC, but you’re not sure which to go with. Which one is better? What are the potential pitfalls of one versus the other? We’ll get you the answers to these questions.
Many retired homeowners turn to home equity lines of credit (HELOC) to cover unexpected expenses. HELOC interest rates and payments are typically reasonable and they’re relatively easy to get if you have equity and good credit. Many accountants, attorneys, and financial advisors recommend HELOCs to their retired clients.
In my opinion, HELOCs are not always a good idea for retirees. There are some pitfalls that can make them risky. But before we explain the pros and cons of a HELOC vs reverse mortgage, let’s cover some basics. There is a lot of confusion and misconceptions about how HELOCs and reverse mortgages work.
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How Does a HELOC Work?
A HELOC, or home equity line of credit, is a revolving home loan that allows you to borrow against your home equity on an ongoing basis and at your convenience. There are several advantages to a HELOC:
- Flexibility. You borrow only what you need when you need it.
- Low monthly payments. HELOC payments are usually interest-only.
- Minimal closing costs. HELOCs usually have minimal or no closing costs.
- Simpler application process. The process to get a HELOC is usually faster and simpler than a reverse mortgage.
Though they have a lot of advantages, HELOCs do come with some downsides:
- You need to have good credit. If your credit has some dings, it may be tough to qualify.
- Interest-only payments. The more you borrower, the bigger your payment. You have to pay extra to pay down the loan balance.
- Adjustable rates. If rates increase, your payment will increase as well.
- Your lender can revoke, chop, or freeze your HELOC with little notice. Wells Fargo closed all of their outstanding HELOCs with almost no notice in the summer of 2021. Even people with high credit scores had their HELOCs revoked.
- The recast. Most HELOCs allow you to withdraw funds for up to the first ten years of the loan. At the ten-year mark, the bank recalculates the loan into a full principal and interest payment that repays the balance over the remaining loan term. This can cause your payment to increase substantially.
In my opinion, HELOCs are best for short-term borrowing. You don’t want to maintain a large balance over the long term because of the recast. I’ve worked with clients who ended up in foreclosure because the recast tripled their monthly payments.
This is something you’ll want to think about as you consider the merits of a HELOC vs reverse mortgage.
Also, don’t forget that a HELOC can be taken away at any time. If your plan is to use a HELOC as a safety net, it’s important to understand that there is no guarantee it will be there when you need it.
A HELOC can sometimes seem like a quick and easy solution if you need cash, but you’ll want to take the time to fully understand the terms and potential risks. The vast majority of people I’ve worked with who had HELOCs were completely unaware of how the recast works.
It’s important to do your homework so you know what you’re getting into.
How Does a Reverse Mortgage Work?
If you’re at least 62, a HECM reverse mortgage enables you to convert a portion of your home’s value into cash.
You remain the owner of your home and can leave it to your heirs. If your heirs want to keep the home, they can pay off or refinance the loan balance. If they don’t want the home, they can sell it and keep the remaining equity.
The HECM is a non-recourse loan; the most you will ever have to pay back is the value of your home. FHA covers the shortage if your home isn’t worth enough to pay off the entire balance.
Since we’re a evaluating reverse mortgage vs HELOC, we’ll focus on the line of credit payout option.
The reverse mortgage line of credit is very similar to a HELOC, but it comes with some important advantages:
- No monthly payments. This is a big advantage of a reverse mortgage vs HELOC. Again, no payments are required as long as you live in the home and pay the property charges.
- The line of credit is guaranteed. As long as you remain in good standing, your line of credit cannot be locked, chopped, or frozen. This is a big advantage of a reverse mortgage vs HELOC; you can rely on the money to be there when you need it. Even better, your available credit will grow and compound larger, giving your access to more money over time.
- Non-recourse. Unlike a HELOC, which is full recourse, HECMs are non recourse. That means you’re not on the hook for the shortage if your home isn’t worth enough to pay off the entire balance.
- No recast. You don’t need to worry about a potential ticking timebomb at the end of ten years.
- Draw period doesn’t end. There’s no time limit on how long you can draw on your line of credit.
- You don’t need good credit. This is a big advantage of a reverse mortgage vs HELOC if your credit has taken some hits. You need perfect credit to qualify for a HECM.
There are some potential downsides to a reverse mortgage:
- Closing costs. Reverse mortgage closing costs can be expensive, but they’re not always expensive. The biggest closing cost is usually the initial mortgage insurance premium, or IMIP. IMIP, along with MIP, is what makes the HECM non-recourse. You’ll likely also incur third-party costs and origination fees. Though HECM closing costs can add up, they’re usually not paid out of pocket. Most lenders will roll them into the new loan amount. The exception is HECM for purchase; closing costs are paid out of pocket in addition to your down payment for purchase HECMs.
- Interest can pile up on large loan balances. If you have a large reverse mortgage balance, the interest can pile rapidly up in the later years of the loan. Again, there are no monthly mortgage payments, so unpaid interest accrues onto the loan balance over time. Interest compounds on top of interest, which means the loan balance can increase rapidly in the later years of the loan. Don’t forget, however, that the HECM is non-recourse. Even if you owe more than your home is worth, FHA will cover the shortage.
- The application process is longer and more involved. It’s possible to close on a HELOC in just a few days, but it usually takes 45 to 60 days to close a reverse mortgage. The application process also involves more paperwork than a HELOC, but your lender will handle most of it.
Like any financial product, a reverse mortgage has positives and negatives. However, in our opinion, the positives greatly outweigh the negatives – especially for retirees on a fixed income. A HECM line of credit lacks the risks associated with a HELOC because there’s no monthly payment required.
You can also rely on the HECM line of credit to always be there. It will never taken away as long as you remain in good standing.
Yes, the costs for a reverse mortgage are significantly higher, but the reverse mortgage is safer. I think this is the most important thing to keep in mind as you evaluate a reverse mortgage vs HELOC.
Reverse Mortgage vs HELOC: Which is Better?
So, which product is better in retirement? Reverse mortgage or HELOC? The answer depends on your goals and financial situation.
Again, a HELOC is not a good long-term financial solution, especially if you’re living on a fixed income. HELOCs are better for short-term cash needs. If you anticipate paying just the minimum interest-only payment on your HELOC for the foreseeable, you may want to consider a reverse mortgage in stead.
As we’ve covered, there’s no payment risk with a reverse mortgage. You can get all the flexibility of the HELOC, but without having to worry about a monthly mortgage payment.
Even better, the line of credit grows over time and you can always rely on it to be there.
Yes, the reverse mortgage is more expensive to get, but it’s a much safer loan if you’re retired and on a fixed income.
The following summarizes what we just covered regarding the reverse mortgage vs HELOC debate. This should help you compare the two loan options side by side and determine which one makes the most sense for you.
|Reverse Mortgage LOC||HELOC|
|Purpose||Long-term cash needs in retirement||Short-term cash needs|
|Age||At least 62||No age requirement|
|Income||Sufficient income (but less than HELOC, usually)||Sufficient income|
|Credit||Good credit not required||Good credit required|
|Residency||Primary residence only||Primary residence only|
|Closing costs||Upfront costs higher *||Upfront costs lower|
|Mortgage insurance||UFMIP and MIP required||UFMIP and MIP not required|
|Loan-to-value||30% to 70%, depending on age and current rates||Up to 80%|
|Line of credit growth||Available credit will grow over time||No growth|
|Payment||No payments required||Payments required (payment can increase if rates increase and at the end of the draw period)|
|Availability||Credit line never revoked or cut||Credit line can be revoked or cut|
|Foreclosure risk||Lower, because no payment required||Higher, because payment required|
|Repayment||Repayment limited to home value||Full repayment, even if home value less than loan balance|
Frequently Asked Questions
Can you have a HELOC with a reverse mortgage?
A HELOC and a reverse mortgage are different loan products. The reverse mortgage offers a line of credit similar to a HELOC, but it doesn’t require a mortgage payment and it comes with a guaranteed growth rate.
Who owns the house in a reverse mortgage?
A HECM reverse mortgage is just a home loan. You always remain the owner of your home and you’re free to leave it to your heirs. The bank does not take over the title of your home when you get a reverse mortgage.