Reverse Mortgage vs. Home Equity Loan: Key Differences And Which To Choose

A reverse mortgage and home equity loan both allow homeowners to turn their home equity into cash, but each has different requirements, advantages, and disadvantages.

We explain how each works and the major differences between the two to help you decide which to use.

What is a reverse mortgage?

A reverse mortgage is a secured loan for homeowners 62 and over with substantial equity in their home. The loan is paid to homeowners in monthly installments, a single lump sum, or as-needed (like a credit line).

Reverse mortgage requirements can be easier to qualify for because there is no credit score or income requirement, though potential lenders will likely check your credit history. Reverse mortgages are also unique in that they don’t need to be paid back until the homeowner dies, moves, or sells the property. However, they are expensive financing tools that decrease the equity in your home as the loan balance grows.

Pros and cons

What is a home equity loan?

A home equity loan is borrowed against your home's equity. You receive the funds in a lump sum and repay the loan in regular installments. The requirements for a home equity loan are more stringent than a reverse mortgage because you need to qualify with your credit score, income, debt-to-income ratio, and equity.

Using your home as collateral makes a home equity loan less expensive, but if you fail to make payments, your lender can start foreclosure proceedings against you. Home equity loans are known for being very flexible. You can use them for just about anything. However, like all financial tools, they have some pros and cons.

Pros and cons

Key differences between reverse mortgages and home equity loans

Increasing equity

The way your equity is used to fund your expenses is different with a home equity loan versus a reverse mortgage. With a reverse mortgage, the monthly payments you receive are added to the loan, with interest and fees. When compounded over time, you begin to lose equity in your home.

On the other hand, with a home equity loan, the equity in your home increases as you pay down the loan.

Taxes

Tax treatment for a reverse mortgage versus a home equity loan is slightly different. You won’t owe taxes on money that you borrow from either, but with a home equity loan, your interest may be tax deductible if you use the funds from the loan to improve your home and take the itemized deduction instead of the standard deduction.

Credit score and income requirements

When you apply for a home equity loan, the lender will consider your income, credit score, credit history, employment status, home value, loan amount, and desired repayment schedule, among other criteria. This is in stark contrast to a reverse mortgage, which has no credit score or income requirements.

Eligibility requirements

The main difference between a reverse mortgage and a home equity loan is the age requirement for a reverse mortgage—as already mentioned, you need to be at least 62. For a home equity loan, age isn’t a factor.

Other requirements for a reverse mortgage include:

• Home must be your principal residence.
• Home must be in good condition.
• Cannot owe any federal debt, such as student loans.
• Must have money set aside for property taxes, insurance, and property repairs.
• Must own the home outright or have substantial equity.

Required equity

Regarding equity requirements, you need a substantial amount to qualify for a reverse mortgage. You should be close to 100% equity if you want a reverse mortgage. Conversely, most lenders only require you to maintain 20% home equity after factoring in a home equity loan.

Interest rate

In our research, we found the interest rate on a reverse mortgage to be lower than on a home equity loan. Be sure to do your own research, as rates can change according to market conditions and your individual circumstances.

Disbursement

With a home equity loan, the money is disbursed in a lump sum all upfront. With a reverse mortgage, you may have the option of taking out a lump sum, receiving monthly payments, or having access to a credit line.

Repayment terms

A reverse mortgage doesn’t need to be repaid until the homeowner sells, moves, or dies. At this point, the entire amount is due. It can be repaid by selling the home, refinancing, using savings, or giving the house to the bank.

A home equity loan begins repayments immediately, typically in monthly installments. If you stop making payments your home may fall into foreclosure.

How to choose between a reverse mortgage and home equity loan

If you still can’t decide between a reverse mortgage and a home equity loan, consider the following comparison:

TIME Stamp: Take extra care when considering a reverse mortgage

Reverse mortgages were designed to help keep older Americans in their homes and stay on top of bills. While they can help homeowners with expenses, you must use caution when taking out a reverse mortgage.

Over the long term, a reverse mortgage may not leave you with much equity and your heirs may need to sell the property to pay off the reverse mortgage. But if it’s the only way to stay in your home and help pay for other living expenses, it might be your best option.

A home equity loan, in contrast, is an installment loan that uses the equity in your home as collateral. If you can handle the monthly payment of a home equity loan, you’ll likely have much more equity in your home and more options as you age.

Frequently asked questions (FAQs)

What is the best option for bad credit?

Reverse mortgages do not have a minimum credit score requirement. If you have bad credit and can’t qualify for a home equity loan, you may want to consider a reverse mortgage.

Can you use a reverse mortgage to pay off a home equity loan?

Yes. A reverse mortgage can be used to pay off a home equity loan, provided there is enough equity in the home. The reverse mortgage lender will want to be in the first lien position and may require any other loans to be paid off.

Which is better for a retired borrower, a reverse mortgage or a home equity loan?

Your individual circumstances will determine which product would work best for you. A financial advisor can help you decide between a reverse mortgage and a home equity loan.