Many homeowners understand that they can borrow against the equity in their homes, typically with a home equity line of credit (HELOC), but many don’t know they have another option. For the right borrower, a reverse mortgage line of credit (RMLOC) can offer a powerful alternative. Both loans provide money to the home borrower. Understanding the difference between a HELOC and an RMLOC starts with knowing key differences in who can qualify and how they work.
How a HELOC Works
A HELOC is a line of credit a borrower opens in addition to their mortgage that allows them to borrow against their equity. The HELOC has a variable interest rate, and the borrower can access funds when needed. The lender sets the approved credit limit on a borrower’s withdrawal amount.
A borrower must typically meet the following requirements to qualify for a HELOC. These requirements may vary from lender to lender.
- Good credit. A borrower must have a good credit score to qualify for a HELOC. Typically, a score in the mid-600s is ideal.
- Solid payment history. Lenders will review a borrower’s payment history.
- Consistent income. The borrower must show proof of income to the lender to demonstrate the ability to make loan payments.
- Enough equity. A borrower should have at least 15% to 20% in home equity.
- Low debt-to-income ratio (DTI). To qualify for a HELOC, a lender will look at the borrower’s DTI. This is the amount the borrower spends to pay off debts relative to the income they bring home. Generally, the lower the DTI, the more likely you will qualify for a HELOC.
Life Stages of a HELOC
Once a borrower qualifies, the HELOC has two distinct stages: the draw period and the repayment period. During the draw period, the borrower can take out money up to the established limit. If the borrower reaches their borrowing limit during the draw period, they may have to pay off some of what they owe before withdrawing more.
The second stage of the loan is the repayment period. Here the borrower will have to start paying the principal and interest on the loan. During both the draw and repayment stages, the borrower must make payments, and the length of these periods will depend on the borrower’s loan amount. If the borrower selects a 20-year HELOC, the timeframe could be a 10-year draw period and a 10-year repayment period.
A lender can cancel or revoke a HELOC anytime for various reasons.
How a Reverse Mortgage Line of Credit Is Different
A reverse mortgage line of credit is one payout option attached to a reverse mortgage. Like a HELOC, a reverse mortgage line of credit allows the borrower to tap their home equity when and if needed. There is no requirement that they use the line of credit at all.
Because a reverse mortgage line of credit is insured, a lender cannot cancel or revoke it. Even if the lender goes out of business, the borrower will not lose the line of credit.
Another characteristic that sets a reverse mortgage line of credit apart from a HELOC is its growth feature. The reverse line of credit grows over time at the same rate as the interest plus the annual mortgage insurance premium charged to the loan. Changes in the home’s value will not affect the line of credit’s growth.
If the borrower chooses a line of credit as a payout option, they can access the funds when they choose. When the borrower takes from the line of credit, the loan balance grows by that amount.
Key Differences Between a HELOC and an RMLOC
Due to the varied qualifications and how each line of credit works, key differences exist between the two loan types in loan eligibility and requirements.
|Home Equity Line of Credit||Reverse Mortgage Line of Credit|
|Age||No age requirement||Borrower must be age 62 or above|
|Home Ownership||Have at least 15 to 20% equity||Substantial equity (above 50%)|
|Credit Score||Must be at least 650||No minimum score requirement|
|Cancellations / Freeze||Can be cancelled or frozen||Cannot be cancelled or frozen|
|Monthy Payments||Payments are required during the draw and repayment period.||No monthly payments required. Balance due at the end of the loan.|
|Growth Feature||None||Line of credit grows even if house value depreciates.|
|Borrower’s Payment History||Lender will consider||Not a factor|
|Annual Fees||A fee is required to keep the loan open.||Borrowers pay upfront and ongoing Mortgage Insurance Premiums.|
Home Equity Line of CreditNo age requirement
Reverse Mortgage Line of CreditBorrower must be age 62 or above
Home Equity Line of CreditNo
Reverse Mortgage Line of CreditYes
Home Equity Line of CreditHave at least 15 to 20% equity
Reverse Mortgage Line of CreditSubstantial equity (above 50%)
Home Equity Line of CreditMust be at least 650
Reverse Mortgage Line of CreditNo minimum score requirement
Home Equity Line of CreditCan be cancelled or frozen
Reverse Mortgage Line of CreditCannot be cancelled or frozen
Home Equity Line of CreditPayments are required during the draw and repayment period.
Reverse Mortgage Line of CreditNo monthly payments required. Balance due at the end of the loan.
Home Equity Line of CreditNone
Reverse Mortgage Line of CreditLine of credit grows even if house value depreciates.
Home Equity Line of CreditLender will consider
Reverse Mortgage Line of CreditNot a factor
Home Equity Line of Credit A fee is required to keep the loan open.
Reverse Mortgage Line of CreditBorrowers pay upfront and ongoing Mortgage Insurance Premiums.
How to Decide Which Type of Credit Line Is Right for You
Since the reverse mortgage line of credit is available only to borrowers 62 years and older, it’s not a viable option for many borrowers. However, if the borrower is eligible, the reverse mortgage line of credit allows the funds to grow even when the home’s value depreciates. Its term is tied to the term of the reverse mortgage, which means it will be available to the borrower and not have a payback period during the life of the loan.
A HELOC may allow you to consolidate debt at a lower interest rate, and the money can be used for anything. However, even though you can borrow as much as you need, a HELOC can be revoked or canceled. And a HELOC has a variable interest rate and functions similarly to a credit card.
When making a decision, it’s a great idea to consult a financial advisor to determine the best fit for your situation.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.