A Reverse Mortgage vs. a Home Equity Loan
As an adult, you know that your financial situation can change rather quickly. One second you have everything figured out with a decent amount in your savings. The next thing you know you have had to shell out thousands of dollars for a few little things and a few big things because obviously everything has to happen all at once. You find yourself needing some extra money just to get the breathing room you need to regroup. Thankfully there are some loan options available that can give you a little bit of extra money while you need it.
Once you realize you need to get some extra money, you have to find out where you can get it from. With all of the loan options out there, you have to take the time to figure out what is best for you. If you’re a homeowner, you have a few extra options than those who do not own a home have. In order to figure out your best options, you have to do some research and maybe even talk to a financial advisor.
If you’re a homeowner looking for a little extra money, you have probably come across both reverse mortgage loans and home equity loans. These can be great ways to get that extra money you’re looking for, but they work in very different ways. In order to know which one is right for you, you first have to understand how each loan works and then look at the key differences.
A reverse mortgage home loan can be taken out by homeowners who are 62 years old or older. The amount of money that you get is based on what your home is worth. Normally when you take out a mortgage on your home you have to make monthly payments to pay it back right away. With a reverse mortgage, you get monthly payments, and the loan balloons. You don’t have to make any payments on this loan until you are no longer living in the house. This type of loan has to be the only or the primary lien on your house. People often take out this type of loan to help them during retirement.
Home Equity Loan
A home equity loan is more like a forward mortgage in that you have to start paying the loan back right away. Unlike the reverse mortgage, this type of loan can be a second lien. This loan is also based on the equity in your home, but you can draw on less of your max credit if you don’t need the entire amount. People often take out this type of loan to help with home repairs or other one time needs.
Now that you understand each loan type a bit better, you have to delve deeper to figure out which one is right for you. The key differences between these loans are:
- Loan Payments: The way you pay back these loans are markedly different. With a home equity loan, you make monthly payments over a period of time. Like a mortgage, the term is normally around 30 years. Because you have to make monthly payments, this type of loan is best suited for someone who can afford to make the payments each month. With a reverse mortgage, there are no payments due until the loan ends which is when the balloon payment is due. The loan ends when you move out of the house for 12 months in a row, you sell the house or you die. Even though there are no payments being made the interest still compounds and accrues until the loan payment is due. Generally, the loan is paid off using the money from selling the house.
- Method of Distribution: When you get a reverse mortgage, you can choose to get all of the money at once or to get monthly payments. Often it is best to get monthly payments, so that you do not spend too much and need to borrow even more money. It’s best to discuss these options with a financial advisor and set up a plan either way. The home equity loan is different because you get credit that you can use to pay medical bills, buy home improvement supplies or really do whatever so long as you do not surpass your limit. Then the loan total is assessed at closing, and you have to start making the monthly payments.
- Tax Differences: When you pay interest on a loan, you get a tax advantage. This means that you can deduct some of the interest from your taxes. A reverse mortgage does not give you this tax advantage, but a home equity loan does. The main difference then is that with a home equity loan you get some of the interest payments back, but with a reverse mortgage you don’t.
- Money Borrowed: The amount of money that you can borrow is also different. On average, a reverse mortgage is going to afford you more money than a home equity loan would. The reason that a reverse mortgage can be bigger is because you have to have the entire house, or very nearly the entire house, paid off in order to get this type of loan. That means that the entire value of your house is your equity. Typically someone who takes out an equity loan still has a mortgage. That means that you can only borrow the difference between what you owe and the value of the home. Depending on your credit and other qualifiers, you may not even be able to get the entire difference.
- Age Restrictions: Another big difference in these two loan types is that a reverse mortgage is only for senior homeowners. You have to be over the age of 62 before you can qualify. When it comes to a home equity loan, there are no age restrictions.
- Other Requirements: Besides age, there are other requirements that homeowners have to meet when they go to take out these types of loans. A reverse mortgage requires that the home is either a single-family home or has up to four units. Some condominiums may qualify. Either way, one of the units or the house has to be occupied by you, the borrower. You also must stay current on the taxes, insurance and other payments related to the house. The house has to be well maintained and well-kept throughout the loan. A home equity loan requires that you have good credit and steady income that will allow you to make the monthly payments. You also have to have a good enough debt-to-income ratio, which is how they can tell if you will be able to make your monthly payments. Sometimes having a foreclosure or short sale in your past could hurt you when you go to apply for a home equity loan.
As you can tell, these two loans are quite different. Now that you know their key differences, it should be easier to figure out which one is really right for you.
Picking the Loan for You
The loan you need depends entirely on your situation. Some might think that if you qualify for a reverse mortgage that must be the right loan to choose, but really it may not be. You have to look at more than just your age. You have to figure out if you would be able to pay the monthly payments for a home equity loan. How much money do you need? If you need a large sum, a home equity loan may not be able to offer you enough. Where are you in your mortgage payments? If you have a long ways to go, you might not qualify for a reverse mortgage no matter your age. Looking at your own personal situation, assessing the loans and talking to a financial advisor are really the only sure fire ways to find the loan that is right for you.
Consider Your Options
That’s just what you have to do. You have to look at all of your options. Don’t just hear about one loan type and then sign your life away. Do your research and talk to a trusted financial advisor. If you’re in a tight spot with your finances, you don’t want to make it worse by getting a loan that will run you further into the ground. You have to know your own limits and the limits of these loan options.
Talk with a financial advisor if you have any questions. You want to fully understand what you are doing before you make sure a big decision. Reverse mortgages and home equity loans are not inherently bad or good. They are the right choice for some people and the wrong choice for others. However, you have to understand the choice fully before you can know if it is really right for you. So, keep comparing. Delve into the ins and outs of these loans. Understand how they work, how they’re different and how they’ll fit into your life.
When you get in a tight spot, it is easy to just jump at the first opportunity that comes your way. However, with finances you have to think before you jump or you will never be able to gain back your financial stability. Contact us for more information, and we will help you figure out what is best for you.