More than half of all Americans have less than $1000 in savings. When it’s time to retire or handle a large expense, some Americans look to loans for a helping hand. But which loan is worth the risk?
If you have equity in your home, you could consider either a reverse mortgage or a home equity loan. Although they share a few similarities, they’re intended for separate situations. Many debtors have trouble differentiating these two types of loans.
Knowing the difference between a reverse mortgage vs. home equity loan is indispensable in times of financial need. Compare and contrast these loans with the help of our short guide.
What is a Reverse Mortgage?
In a typical mortgage scenario, you arrange a loan with a lender and use the lump sum to purchase a home. You gain a growing share of the equity every time you put a payment towards the debt. Eventually, you’ll pay back the entire loan and control all equity of the property — which means the home is officially yours.
A reverse mortgage is, as you would expect, the exact opposite of a traditional mortgage. If you own a home, you can sell the equity back to a reverse mortgage lender. These institutions make payments to purchase this equity from you, usually through monthly installments or a large lump sum.
These payments are tallied in the form of debt. Once you pass away, abandon, or sell the property, the mortgage lender will seek repayment for the debt. As the equity owner, they will sell the house to settle the debt and transfer the surplus to you or your relatives.
For more reverse mortgage resources, check out The Steven J. Sless Group.
What is a Home Equity Loan?
A home equity loan is otherwise known as a second mortgage. It’s similar to a reverse mortgage in that it uses your equity as collateral. There are two different types of home equity loans.
The typical home equity loan gives you all the money you need as a lump payment. It’s called a second mortgage because you’ll have to make payments towards this debt every month, just like a normal mortgage. You’ll also have to contend with interest rates and a fixed repayment term.
You could also spring for a home equity line of credit, known as a HELOC. Since it’s a line of credit, it’s like using a credit card. You’ll have a set credit limit based on your equity and can borrow up to a certain amount.
While a home equity loan has a fixed rate of around 8.76 percent, a HELOC is variable and often higher.
Reverse Mortgage vs. Home Equity Loan
While a reverse mortgage and home equity loan share many similarities, they’re entirely different entities. Which works best for you will depend on your personal situation. Let’s take a deeper look at these loan disparities.
1. Ease of Getting the Loan
In general, a reverse mortgage is specialized and thus more difficult to qualify for. It’s only available for homeowners aged 62 or older. These homeowners must own all or most of the equity in their property.
Home equity loans are easier to obtain. You can snag a home equity loan at any age, but you need to have around 20% equity in your home. You’ll also be beholden to standard loan factors, such as employment and credit history.
For homeowners 62 years or older, getting a reverse mortgage is the easiest option. But for everyone else, a home equity loan is more accessible. In fact, it may be the only option.
2. Payment Methods
By far, a reverse mortgage offers a variety of different payouts. Whether you want monthly installments, a lump sum, or something else, most reverse mortgage institutions are willing to work with you. This gives you unrivaled flexibility compared to a home equity loan.
And that’s because a home equity loan is always received as a lump sum. From there, you’re responsible for making the monthly payments. A HELOC offers more control over the money you receive, but also comes with the burden of a high interest rate.
A reverse mortgage is typically a great option for retirees who desire additional income. In contrast, a home equity loan is usually the go-to option for younger couples who need to pay for a large expense. This expense is often home-related, such as a kitchen remodel.
3. Repaying the Loan
A reverse mortgage is a great deal for the homeowners. They’ll enjoy the equity as it converts into cash payments, allowing them more freedom to enjoy their retirement. But eventually, the mortgage lender will come calling for full repayment.
Since these homeowners typically don’t have to sell the house until they pass away, they’ll never have to worry about the loan. It will detract from the family inheritance, however, should their children be unable to buy the house from the lender.
But a home equity loan isn’t safe, either. If one mortgage wasn’t bad enough, then two can break the bank. And when these homeowners fail to repay their home equity loan, they could lose their home as collateral.
The Decision: Reverse Mortgage vs. Home Equity Loan
Yes, these types of loans both rely on your equity. But a reverse mortgage pays you in exchange for homeownership while a home equity loan must be repaid by traditional means.
The choice between a reverse mortgage vs. home equity loan isn’t clearcut. If you’re considering a loan based on your equity, take stock of your financial situation before seeking out a lender.
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