What’s the difference between a Reverse Mortgage and a Home Equity Loan?
A reverse mortgage, also knows as a Home Equity Conversion Mortgage (HECM), is a special type of FHA-backed mortgage program designed to help senior homeowners. While the name sounds similar to a home equity line of credit (HELOC), the two are very different.
A HELOC works in a way similar to a credit card. The lender agrees to advance the borrower up to X amount of money at a time and amount of the borrower’s choosing. For example, with a traditional mortgage, you may borrow $200,000 to pay for the purchase of a home. With a HELOC, your lender will give you access to a line of credit using your home’s equity as collateral. You can draw from that line of credit by writing checks, using a special credit card, or both.
HELOCs are typically considered second mortgages, but they can be used as first mortgages if being used to refinance an existing first mortgage. Using a HELOC can save you money in the short term, but they are considered very risky. HELOCs are a type of adjustable rate mortgage (ARM) but are much more risky than standard ARMs. Because the interest rate on a HELOC may be calculated daily, it can spike dramatically from day to day. Furthermore, most standard ARMs have rate adjustment caps which limit the size of the rate change. HELOCs may not have rate adjustment caps.
It should also be noted that, with a HELOC, borrowers must make monthly payments on the principal and interest of what they are borrowing. In a reverse mortgage, or HECM, the borrower is not required to make payments on principal or interest. In fact, the reverse mortgage does not need to be paid back at all until the last remaining homeowner on the mortgage has moved or is deceased.
Also, with a reverse mortgage, the borrower actually receives payments from the lender instead of the other way around. The money is still coming from the home’s equity; however, the homeowner is not burdened by principal and interest payments. This is why reverse mortgages are a popular choice for homeowners who are living on a fixed income, are trying to pay off other debts, or want an alternative to living in an expensive retirement or nursing home. A reverse mortgage gives the senior homeowner the financial freedom to plan for the future without having to struggle in the present.
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Although reverse mortgages are strictly regulated, homeowners should be cautious about where they find information on reverse mortgage programs. Not that long ago there was a rash of predatory lending going on in the reverse mortgage field, with many senior homeowners falling victim to misinformation that eventually led to the foreclosure and loss of their homes. To avoid this, every homeowner who considers a reverse mortgage should know exactly what the program requires.
One requirement of a reverse mortgage is that the borrower must continue to pay real estate/property taxes, utilities, and homeowners insurance premiums. Failing to do so can cause the reverse mortgage to go into default and may eventually lead to foreclosure.
Be sure to speak with a licensed mortgage professional who specialized in Home Equity Conversion Mortgages if you are thinking about taking out a reverse mortgage. You can also find some helpful information on the Department of Housing and Urban Development (HUD)’s website: http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/hecm/rmtopten