Reverse mortgage vs. HELOC: How to choose

Everyone needs to borrow money from time to time, whether it’s for home improvements or even just daily living expenses. Home equity loans and lines of credit (HELOCs) are popular options because they’re often cheaper than tools like credit cards. 

If you’re a homeowner and at least 62 years old, though, you have an additional option compared to younger homeowners: a reverse mortgage. These two products can address similar funding needs, but ultimately, their ongoing requirements, costs, and end stages are very different. 

We’ll help you compare the pros and cons of a reverse mortgage vs. HELOC so you can feel confident in making an informed decision.

Reverse mortgage vs. HELOC: A quick comparison

We’ll go into more depth further down about how to choose between a reverse mortgage and a HELOC. Sometimes, though, it helps to see the main differences up front:

How reverse mortgages work

Most homeowners are aware that a reverse mortgage, as the name implies, works by drawing funds against your home equity. A key advantage of reverse mortgages — and a major difference with any other loan — is that you don’t have to make monthly payments. It’s a primary reason why many retirees on a fixed income choose a reverse mortgage in the first place.

You’ll repay the loan when you move out, pass away, or fail to keep up with property taxes, home insurance, or home maintenance. Thus, reverse mortgages don’t have set loan terms, per se, although your balance will continue to grow over time with the addition of ongoing fees, mortgage insurance premiums, and interest. This often makes reverse mortgages a very costly way to borrow over the long run, even if you aren’t making regular payments on the debt. 

Most lenders offer reverse mortgages through HUD’s Home Equity Conversion Mortgage (HECM) program, which sets strict rules that protect both the lender and you, the borrower. This sets the upper bounds for individual lenders in terms of how much they can lend to you and how much they can charge. It also requires that lenders offer you certain protections:

• You must first complete individual, one-on-one counseling with an approved counseling agency before taking out an HECM.
• Your spouse may be able to stay in the home when you’re gone, even if they’re not listed on the loan.
• You — or your estate — won’t ever owe more than your home’s actual value, even if your balance grows to exceed that amount. 
• Your heirs get the first right of refusal to purchase the home, along with a 5% discount if the loan balance exceeds the home’s value. 

How HELOCs work

A HELOC or home equity loan is more appropriate for homeowners with steady incomes who can afford to repay the debt, and who are seeking a flexible financing option in the form of a line of credit. (Reverse mortgages also offer a line of credit option, by the way, but it’s not designed to be repaid in the same way as a HELOC.)

Instead, HELOCs are typically structured as a two-part sequence: a draw period, followed by a repayment period. Each works differently:

• Draw period (10 to 15 years): Borrow funds as needed up to a pre-set credit limit. Typically, lenders require only interest-only payments during this period. 
• Repayment period (10 to 20 years): You can no longer borrow funds, and the debt essentially converts to a loan. You’ll make full interest and principal payments to repay the debt.

Lenders typically charge adjustable interest rates during the draw and repayment periods, although some may offer a fixed-rate option. 

The combination of variable rates, plus the jump from interest-only minimum payments during the draw phase to full payments during the repayment phase, can make it hard to manage HELOC payments if you borrow a lot of money. Experts recommend planning ahead for these changes and limiting the amount of debt you carry, if possible.

When to choose a reverse mortgage vs. a HELOC

Both options — HELOCs and reverse mortgages — can help address funding needs in retirement. However, each product works very differently, and the stakes are much higher than for other loan types. We’d recommend speaking with a fiduciary financial advisor or counselor who can provide unbiased advice.