Should I Get a Reverse Mortgage or a Home Equity Line of Credit?
Should I Get a Reverse Mortgage or a Home Equity Line of Credit?
Before we start, let's get the definition of a normal mortgage out of the way.
Mortgages are loans given to people to purchase a property with. The money that you borrow is then repaid over several years, together with interest. To get a mortgage, you need to have a good credit score and be able to prove that you can afford the repayments.
What is a reverse mortgage?
A reverse mortgage is completely different from a normal home loan. With the traditional mortgage, you're borrowing money to purchase your house and then repay it over time with interest. With a reverse mortgage, as the name suggests, you're taking cash out of your property. You cannot take out the full amount of your property's value as part of a reverse mortgage.
In Canada, a reverse mortgage works by looking at your age, your home's equity, and your home's location. This will determine how much of your home's value you can take out as a reserve mortgage loan.
You can take out your reverse mortgage money in two ways. Either a lump sum payment or monthly payments.
As opposed to a standard loan, a reverse mortgage lender will need to look at your age. Both you and your spouse need to be over the age of 55 to qualify.
When do I have to pay the money back?
A reverse mortgage still means that you need to pay the mortgage amount back to the lender. For a reverse mortgage though, you can borrow money and not worry about paying it back until a few specific situations.
- You sell your home.
If you sell the home, you need to pay back the full loan amount including the interest rate accumulated to the financial institution that financed the reverse mortgage.
- You move out of your home.
Reverse mortgages assume that the home equity is that of your primary residence. If you move out to live somewhere else then your is no longer your primary residence.
- The last living borrower dies.
If you pass away while using a reverse mortgage then the responsibility of paying back the loan falls on your spouse if you have one. If your spouse passes then your estate has about six months to repay the loan amount. Usually, heirs will decide on what to do.
It's common for heirs to sell the home to pay for the reverse mortgage but they may pay off the loan with another source of funding and keep the house.
- You default on the mortgage
Defaulting on the reverse mortgage means breaking the agreement between you and the company providing the reverse mortgage. Defaulting on the loan can also happen if you use the money for illegal purposes or let your house fall in value by neglecting it.
What are the cons of a reverse mortgage?
- You need to meet the requirements to qualify for the reverse mortgage.
Everyone who legally owns the home is required to be 55 or above, your home must be in good condition, and you must have some equity in your home.
- High-interest rates.
Loans work by making people repay more than they borrowed by adding an interest rate to the principal borrowed and making people repay fixed monthly payments that include a portion of the principal along with the interest rate. The interest rate for reverse mortgages is much higher than other loans or mortgage products.
- Risk losing your home.
If you default on the mortgage, then the financial institution that provided the loan will need to get the reverser mortgage amount back. If you are unable to pay it back then it may sell the house as a way to make back the amount it loaned. This is one of the biggest cons of a reverse mortgage but defaulting on your mortgage is not something that happens easily. Be sure to check your contract carefully and talk at length with a financial advisor.
- Start-up costs
With a setup fee and appraisal fees to get the reverse mortgage started, the cost of this personal loan can be out of reach for some people.
What are the pros of a reverse mortgage?
- No prepayment penalty.
Prepayment penalties are fees that your lender may make you pay if you do things like paying your entire mortgage before the end of its term. When you have a reverse mortgage, you can repay the full loan amount - principal and interest payments - at any time before one of the conditions outlined previously without having to worry about prepayment penalties. You can pay your reverse mortgage early with no negative repercussions.
- Great if you're cash poor but house rich.
As opposed to a regular mortgage, the only thing that matters when taking out a reverse mortgage is your age and the condition of your home. If you need an infusion of cash, if you are on a limited income for example, then you can use the reverse mortgage to improve your cash flow.
Compared to other loan options, this one allows you to cover things like healthcare expenses or living expenses and worry about making payments later down the line. You still have to pay the outstanding balance but without a monthly payment to take care of, your monthly cash flow will be vastly improved.
- Maintain ownership.
If you do not default on your loan, reverse mortgages allow you to retain ownership of your home in circumstances where you could have lost your home. By using the money to make regular monthly payments you can get back in good financial health without losing your home.
Where can I get a reverse mortgage?
Two banks offer reverse mortgages in Canada. HomeEquity Bank and Equitable Bank. Both of these financial institutions have to adhere to rules imposed by the government as a reverse mortgage is seen as one of the government benefits available to older Canadians.
What is a home equity line of credit?
A home equity line of credit (HELOC) is a type of loan in which the borrower uses their home as collateral.
They can then use home equity lines of credit to borrow money for any purpose, such as to pay for a child's college education or to make home improvements.
The interest rate on a HELOC is usually lower than that on other types of loans, and the repayment terms are flexible. However, if the borrower defaults on the loan, they could lose their home.
A home equity line of credit is not a standard home equity loan.
Home equity loans are one-time lump sum payments on up to 80% of the home's values. A line of credit is a revolving credit product.
Home equity lines of credit are complex.
Some banks and lenders will offer an equity line of credit combined with a mortgage when someone purchases a home. This is not a comparable product to a reverse mortgage. There is another type of home equity line of credit that is more similar to a reverse mortgage and that is a stand-alone home equity line of credit.
To put it simply, a stand-alone HELOC is like having a credit card with a balance equal to that of the equity of your home. It can go up to 65% of the current market value of your home. Like a credit card, it will require regular payments based on the amount you use.
Reverse Mortgage vs Stand-alone Home Equity Line of Credit
Both of these financial instruments allow you to use your home equity to use more money than what you have available in your bank account.
One of the key differences between either product is the interest rates. HELOC rates tend to be lower and easier to pay back while reverse mortgages can be tough to repay, especially on a fixed income.
Using either product incurs the risk of losing your home but a HELOC only requires that you pay back what you use with a small amount of interest. A reverse mortgage paid out in a lump sum payment and compounded interest payments may be far harder to pay back.
Both have a long draw period - if you decide to withdraw increments out of your reverse mortgage rather than a lump sum - and can be used on an 'as needed' basis.
In the end, the choice comes down to your specific situation when it comes to what product is the best for you.
If you need to stabilize your income because of unforeseen expenses then a reverse mortgage is more suitable because it allows you to take your time to repay the loan.
If you need to use some of your home's equity for another large purchase (like a downpayment for another house) then a home equity line of credit is the right product for you.
The best course of action, before making any definitive decision is to talk to a mortgage broker to figure out if either of these products or something else can help you achieve your financial goals.
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