Reverse Mortgage vs. Home Equity Loan: Everything To Know

Reverse mortgages and home equity loans both assist homeowners in accessing their home equity and translating it into cash. After buying a home, you have the opportunity to build its equity as you continue paying down the mortgage. You can then turn your home equity into cash by obtaining a reverse mortgage, home equity financing, or home equity line of credit (HELOC) if you’ve reached a certain percentage of equity. 

Here are the distinctions and similarities between reverse mortgages and home equity loans.

What Is a Reverse Mortgage?

A reverse mortgage is a loan type available for homeowners ages 62 years and older. It allows them to convert a portion of their home’s equity into cash without having to sell the home or make monthly mortgage payments. This type of loan is typically repaid when the homeowner sells the home, permanently moves out of the home, or passes away.

There are instances where the borrower’s spouse can continue owning the property if the mortgage was acquired while they were in the residence. During the reverse mortgage period, taxes and other real estate insurance remain your responsibility.

Types of Reverse Mortgage

You will encounter three categories of reverse mortgages: home equity conversion mortgages (HECMs), single-use reverse mortgages, and proprietary reverse mortgages. 

Home Equity Conversion Mortgage (HECM)

HECM is reverse mortgage financing with adjustable funds protected by the Federal Housing Administration. The borrower may obtain the money in the form of a lump amount, a line of credit, or monthly installments, and it can be used for any purpose. Since this financing is non-recourse, the amount you owe is limited to the value of your house.

Single-Purpose Reverse Mortgage

Single-purpose reverse financing is disbursed by the lender with regulations on how it should be utilized. The uses of this loan must be approved by the lender, such as home renovations and tax payments. These loans are usually less costly than HECMs, and the requirements involved in acquiring them depend on the lender. This type of reverse mortgage is usually offered by state or local government agencies or nonprofits. 

Proprietary Reverse Mortgage

Proprietary reverse mortgages offer financing for high-end homes that exceed the limit of HECMs and single-use loans. These loans are offered by private financiers and have fewer restrictions and obligations than the other reverse loans.

Advantages of Reverse Mortgages

Reverse mortgages have the following advantages:

• Unlike a traditional mortgage, you don’t make monthly payments on a reverse mortgage. Instead, the loan balance gradually increases over time as the interest and other fees are added to it. 
• Reverse mortgages provide homeowners with access to their home equity without having to sell the home.
• Homeowners maintain ownership and can continue living in the home as long as the loan requirements are met. This means maintaining the property and paying the taxes. 
• There is no impact on Social Security or Medicare. Reverse mortgage payments don’t count as income, so they will not affect a homeowner’s eligibility for these programs. 

If the homeowner with the reverse mortgage passes away, the loan becomes due, and the lender expects to be repaid. However, if the homeowner has heirs or a surviving spouse, they can choose to sell the home to pay off the balance, pay the loan balance to keep the home, refinance the reverse mortgage with a new loan, or seek non-recourse protection. This means if the loan balance exceeds the actual value of the home, the heirs aren’t responsible for paying the difference. 

Disadvantages of Reverse Mortgages

While a reverse mortgage can be beneficial for older homeowners, there are still some disadvantages to be aware of before choosing this option. 

• Since you aren’t required to make monthly payments on a reverse mortgage, the interest is tacked onto the loan over time. This means that the amount increases every month, and as it sits unpaid, the balance increases.
• These loans are often more costly because they can have higher fees and costs than a traditional home equity loan or line of credit. For example, there may be origination fees, closing costs, and mortgage insurance premiums.
• Borrowers risk foreclosure if they don’t pay property taxes, and you can’t deduct the interest on your tax return. If you fail to maintain the property or stay up to date on the tax payments, the loan can become due. This is a serious risk for homeowners who may have financial difficulties and can result in the loss of the home.
• There are also restrictions on property types, and not all homes qualify for a reverse mortgage. Vacation homes or investment properties, for example, are not eligible. They also may not be available for co-ops or manufactured homes. 

Home Equity Loan

Home equity financing is the total amount a borrower receives upfront and repays over a predetermined period. Depending on their credit score, the lender’s terms, and other factors, a borrower can receive up to 85% of the home equity with a home equity loan.

Homeowners can use these funds for their personal needs and can repay the loan in installments soon after getting the financing. Home equity loans are often called second mortgages because you pay for them together with the original loan. The loan can come from the equity of your primary residence and often comes with fixed interest charges.

Advantages of Home Equity Loans

• There are no limitations on how the borrower can use the funds.
• Qualifying for home equity loans is easier than other loan types because the requirements for property equity, credit score, and debt-to-income ratio details are less strict.
• Home equity loans often have lower interest rates than other financing options like credit cards.
• You can resolve your financial needs with a one-time lump sum instead of waiting for installments to complete the major projects you have on your list.
• The repayment period is usually longer, which allows you time to pay off the loan with lower installments.
• The monthly installments are fixed, and you can budget for your loan comfortably.

Disadvantages of Home Equity Loans

• Borrowers who default on the loan risk foreclosure since their home acts as collateral.
• If you decide to sell the property, you may end up paying for two loans since the money may be insufficient to repay the mortgages.
• You are required to pay for the closing fees, which cost around two percent to six percent of the loan amount.

How to Choose Between Reverse Mortgage and Home Equity Loan

Reverse mortgages are ideal for older people who need a supplementary income for comfort and those who don’t wish to move out of their primary residence. For people who need to cover expensive bills or house repairs, home equity is available. Borrowers might utilize a home equity loan to settle a high-interest debt or cover smaller home renovation tasks. 

RenoFi as an Alternative to Traditional Home Equity Loans and Reverse Mortgages

Let’s say you need funds for large home renovation projects. RenoFi loans could be an alternative to a reverse mortgage, allowing you to borrow funds based on the future value of the home after the improvements are made.

Unlike a reverse mortgage, RenoFi loans are not age-restricted and don’t require homeowners to give up the equity in their homes. Instead, RenoFi is a flexible financing option homeowners can use to fund major renovations without all the limitations and costs often associated with reverse mortgages. 

RenoFi loans are also a great choice compared to a traditional home equity loan because they are based on future home value, provide higher loan amounts, and may offer lower interest rates. 

Here’s a simple example where you want to spend $150,000 to renovate your new home and increase the value of your home by $150,000:

Scenario 1 (New Home Purchase): Using the same example above 

• Home price: $600,000
• Downpayment (20%): $120,000
• Current Mortgage Amount: $480,000

Example Home Equity Loan Amount: 

• $600,000 * 80% = $480,000 (80% of Total Home Value)
• $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $480,000 = $195,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).

Without RenoFi loans, you would not have been able to borrow the $150,000 needed to add the renovations that would increase the value of your home by $150,000. Now, with RenoFi loans, you are now able to get the loan you need to add the renovations you want to your home.

Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:

• Home price: $600,000
• Current Mortgage Amount: $420,000

Example Home Equity Loan Amount: 

• Example Home Equity Loan % of Home Price: 80%

• Example Home Equity Loan Amount: 

  • $600,000 * 80% = $480,000 (80% of Total Home Value)
  • $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $420,000 = $255,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value). 

Here’s a summary of the difference between traditional and RenoFi home loans in table form: 

In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:

• No draw periods
• No inspections
• No need to give up your original loan
• Higher borrowing limits

RenoFi loans are funded on the day the loan is closed and that is it. Take out the $195k and you get $195k in your bank and you have 20 years to pay off in equal monthly payments with interest and principal, just like a standard mortgage.

If you are considering a home renovation, RenoFi is by far the smartest way to finance your project. Learn more and explore your borrowing options.

Get Started With Your New Financing Today

Choosing the right home renovation loan can make or break your project. While traditional loans like reverse mortgages, home equity, HELOCs, personal, or FHA 203(k) loans have their place, they often come with limitations that can restrict your renovation plans. But RenoFi loans give homeowners a unique and flexible alternative. 

By leveraging your home’s after-renovation value, RenoFi allows you to borrow more without the need to refinance your existing mortgage or deal with complex draw schedules and inspections. Therefore, if you are a homeowner looking to maximize your renovation potential, RenoFi loans are the best choice.

Unlike traditional loans, which are based on your current home value or require you to refinance, RenoFi loans are based on the after-renovation value of your home. This allows you to borrow, on average, 11x more, get a low monthly payment, and keep your low rate on your first mortgage.

Explore your RenoFi loan options here.