What are reverse mortgages and home equity loans, and which one will work best for your situation? We’ll help you learn the difference and explain why each may be beneficial to you.
Both reverse mortgages and home equity loans are able to help you right now, as well as during your retirement years and beyond. A lack of knowledge about the types of loans available to homeowners prevents them from tapping into all the benefits home equity products have to offer.
If you are worried about how you will keep up with the rising cost of living, increasing home expenses, and debt in your post-retirement years, then read on.
What Is a Reverse Mortgage?
A reverse mortgage is a type of loan that allows you to get money from your home equity. It is secured against the value of your home. The amount you are able to borrow depends upon your age, your home’s value, and your lender.
To be eligible for a reverse mortgage, you must be at least 55 years of age and you must be a homeowner.
You may access the money from a reverse mortgage in one of two ways:
- As a one-time lump sum OR
- Taking some money upfront and the rest over time
Reverse mortgages allow you to access your home equity without selling your house, turning it into tax-free cash that can help you with any outstanding debt or living expenses.
The main factor differentiating a reverse mortgage from other types of loans is that there are no monthly mortgage payments associated with it. You do not need to make any principal or interest payments until you and your spouse leave the home. This is beneficial to those in retirement who do not want to add to their monthly payments or expenses.
Reverse mortgages are named as such because, as opposed to a homeowner making payments to their lender, the lender is now making payments to the homeowner. Interest on the loan is rolled into the loan balance, so the homeowner doesn’t need to make any payments upfront. The home title stays in the homeowner’s name until they move out. Over time, home equity decreases while the homeowner’s debt increases.
With a reverse mortgage, the collateral is the home. When the homeowner sells or loses possession of the house, the money from the sale goes toward the lender to repay the reverse mortgage’s principal, interest, etc. Any leftover money will either go to the homeowner or the homeowner’s estate.
The main pros of a reverse mortgage are as follows:
- No need to make regular loan payments
- No tax paid on money borrowed
- You can turn some of the value of your home into cash without selling it
- You still own your home
- You have options as to when and how you receive the money
The main cons of a reverse mortgage are as follows:
- Interest rates can be higher than other types of mortgages
- The equity you hold in your home might go down as interest on your loan adds up over time
- Your estate is responsible for paying back the loan within a certain timeframe in the event of death
- There may be less money to leave to your children and other beneficiaries in your estate
What Is a Home Equity Loan?
A home equity loan is a loan for a fixed amount of money that is secured by your home. Your lender gives the loan, and the total amount of the loan is provided upfront. A home equity loan is great for those who need access to cash for renovations or other larger purchases. Interest rates on home equity loans tend to be lower because they are secured against your house’s value.
Home equity loans have a fixed payment term and a fixed interest rate. It is payable each month, just like your mortgage.
If you do not follow the payment terms as agreed, your lender is able to foreclose on your home as collateral.
You are only able to borrow a limited 85% of the equity in your home. The actual amount of the loan depends on your income, credit history and the market value of your home as well.
Home equity loans are best if you need money for a one-time expense. But if you need a small amount of cash, then they would not be right for your needs. Many lenders won’t approve loans of less than $25,000. Additionally, all closing fees are the same as a first mortgage, no matter what amount of money the loan is.
Home equity loan pros:
- Lower interest rates than other types of loans, and typically come with a fixed interest rate
- They are an easy way to obtain a large amount of money in a short time
- They are secure loans secured by your home’s value
Home equity loan cons:
- If you fail to make payments on the loan, your financial institution or lender may take your home as collateral
- You may become more in debt if you take out a second loan to pay off student debt or other bigger loans
- Similarly, you may face bankruptcy if you take out a home equity loan, which is worth more than the value of your home
Which One Is Right for You?
When taking all of this into consideration, which type of loan is best for you? The main factor when deciding hinges upon how and when you are able to repay your loan. A home equity loan requires more discipline and more risk, but has lower interest rates than a reverse mortgage. A reverse mortgage is great if you are looking for a long term income solution. Both have different risks, so you must review all of your options before deciding. Be sure to shop around at different financial institutions or lenders. Ask them about their fees, interest rates, penalties, and payment terms. Take the time to become educated so you can make a smart financial decision.
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