As people hit their later years, the idea of freeing up cash flow for extra needs comes into vogue and has been considered by many. The typical financial tool that many retirees see themselves considering is a reverse mortgage, but it’s not the only equity tool available.
The equity loan, or second mortgage, is essentially an additional fixed loan attached to the home. However, unlike the first mortgage being used to buy the home, the second mortgage can be used for other purposes such as putting in a pool, redesigning the home to make it easier to live in, or to pay for a big travel trip somewhere. This kind of loan can also be set up for a long pay period which reduces its monthly pay impact, and the fact that it is attached to the home produces a very low interest rate cost. However, one does have to have the income or assets to pay it back, which can be challenge for those on a set income path.
The equity loan line of credit, or HELOC, works similar to the equity loan, but it is not fixed. Instead, the HELOC works more like a credit card. The homeowner charges against the line, develops a balance and pays it, but can then borrow again. Similarly, the interest rate is low because the HELOC is attached to the home for collateral, but the borrower is not under demand to deal with all the loan value at once. So the HELOC can actually produce a lower monthly payment back and can be used multiple times.
The reverse mortgage takes the equity out of an owned home and provides it back as cash to the borrower. However, there is no monthly payment, a key benefit compared to other tools. Instead, the loan principal and interest growth sit on balance and are paid back at a set date at the end of the loan life. This means that either the borrower pays the loan in full with a balloon payment at the end or turns transfers the home itself to satisfy the loan due. However, the owner always stays in the home until leaving it or if he or she passes away.
The loan is never more than the home at the time of origination, so in most cases the home value has risen and is more than enough to pay the loan. There are requirements, however. For example, the borrower and all on the loan must be age 62 or older, the property must be fully clear of any other financing, the borrowers must own a sizable equity in the home already (usually 40 percent or more), and if a borrower leaves or dies the loan usually comes due. That said, many have found the reverse mortgage to be a powerful way to boost monthly cash flow in their lives, making later years far more comfortable.
All three equity borrowing tools are effective at giving a homeowner more cash flexibility, but they have different risks to know and be aware of. A homeowner is not locked into one path and really should consider all options before choosing a particular tool.