If you are a homeowner you may be considering ways in which you can convert your home equity into cash. You may need the funds to pay for living expenses, healthcare costs, a home remodeling job or other necessities or you may just want to use some of the equity that you’ve built up over the years for a vacation or other project.
If you’re looking into these options and you are aged 62 or older you have two choices. You can access a home equity loan or you can take out a federally-insured Reverse Mortgage, also known as a Home Equity Conversion Mortgage (HECM) loan. Both of these alternatives give you the chance to tap into the equity that you have in your property without the need to sell or leave your home. Each of these products has its pros and cons so you should be sure that you understand your options before you make your decision.
In general, buyers purchase their new home with a forward mortgage. The forward mortgage, also called a “regular mortgage,” involves borrowing money from a lending institution and then making monthly payments to pay down the principal and the interest. Over time, the debt decreases as the buyer’s equity increases so when the homeowner has paid off the mortgage in full, he’ll have full equity and own the property outright.
A reverse mortgage reverses the process: Instead of making payments to a lender, a lender makes payments to the homeowner, based on a percentage of the home’s value. Over time, the debt increases (as payments are made and interest accrues) so the homeowner’s equity decreases as the lender purchases more and more of the equity. The homeowner continues to hold title to the property. If the homeowner dies or moves away, becomes delinquent on property taxes and/or insurance or allows the home to fall into disrepair, the loan becomes due. At that point the lender sells the home to recover the fees and the money that was paid out. Any equity left in the home goes to the borrower’s heirs.
If both spouses have signed onto the reverse mortgage, the bank cannot sell the house until the surviving spouse dies.
A home equity loan works in the same way as a Reverse Mortgage in that it lets you convert your home equity into cash. It is similar to a forward mortgage – in fact, a home equity loan is also called a second mortgage. Borrowers receive the loan as a single lump-sum payment and can make regular payments to pay off the principal and interest, which usually involves a fixed-rate.
There’s another type of home-equity loan as well, called the home equity line of credit (HELOC). With this type of loan borrowers have the option of borrowing up to an approved credit limit. While borrowers pay interest on the entire loan amount with a standard home equity loan, they’ll pay interest only on the money they actually withdraw with a HELOC. HELOCs are adjustable loans with monthly payment changes that fluctuate as interest rates change.
Interest that borrowers pay on reverse mortgages is not tax-deductable but the interest that is paid on home-equity loans and HELOCs can be deducted from a borrower’s taxes for loan amounts up to $100,000.
Some additional points regarding each of these loan options are:
· The borrower retains title to his home
· Borrowers can draw their payments as a line of credit or as monthly payments
· Borrowers can access up to 60% of their equity during the first year of the loan
· Medicare benefits are not affected by a Reverse Mortgage but Medicaid benefits may be affected
· Social Security retirement benefits are not affected by a Reverse Mortgage but Supplemental Social Security payments may be affected
· Taking out a Reverse Mortgage involves paying third party costs (loan origination fee, mortgage insurance fee, appraisal fee, title insurance fees, and various other closing costs ) and interest on the loan
· A reverse mortgage will almost always decrease the equity in the property so less money will be available to heirs
· Home equity loans are secured and approval can be based on solely on the borrower’s credit score, giving the potential borrow a high chance for approval.
· A line of credit from a Equity Loan can act as backup, at a lower rate than credit cards.
· Equity loans are suggested for individuals who need to cover expenses for a short time – they are not a long-term solution.