HECM vs. HELOC: Which Should You Choose?
You know that you’d like to free up the equity in your home for other uses. Whether it’s to pad your retirement income, make home improvements, or pay off debt, home equity is a valuable asset that can help you meet your financial goals.
But what is the best way to access and use that equity? Two common approaches are a home equity conversion mortgage (HECM) and a home equity line of credit (HELOC).
The best choice for your needs depends on several factors, including your age, the amount owed on your existing mortgage, and how long you plan to stay in your home. Keep reading to learn more about HECM vs. HELOC loans and some home equity loan alternative options when neither suits your situation.
What is a HECM?
A HECM is a reverse mortgage option for seniors aged 62 and over who have a small loan balance remaining on their traditional mortgage loan or own their homes outright. The HECM is the only reverse mortgage loan option backed by the federal government, making it a secure option for those who can qualify for the program.
- In a HECM reverse mortgage loan, the borrower receives a loan from an FHA-approved lender.
- The funds from the loan are then used to pay off the remainder of the mortgage, if applicable.
- Any remaining money is the borrowers to use however they choose.
A HECM reverse mortgage doesn’t require that the HECM borrower make any payments on the loan. Instead, the loan is repaid when the HECM borrower passes away or sells the home. The proceeds of the home’s sale are used to pay off the HECM loan. The homeowner is, however, responsible for the property taxes and homeowners insurance payments for the home.
What is a HELOC?
A HELOC is a line of credit that uses the equity in your home as collateral.
A HELOC differs from other home equity loan types in that you don’t receive the funds upfront. Instead, you have an open line of credit from which you can draw funds as needed. However, like home equity loans and other borrowing methods that use your home as collateral, it functions as a second mortgage.
You can usually borrow as much as 85% of the appraised value of your home minus what you owe on your mortgage. The lender will take your credit history and your total amount of outstanding debt into account to determine the exact credit line you’re eligible for.
When you use the funds from your HELOC, you have to make payments. The monthly payment amount will vary, depending on how much of your credit line you’ve used. Often, these loans have a large balloon payment due at the end which makes them quite risky for a homeowner. Since your home is the collateral, you put yourself at risk of losing it if you can’t make the necessary payments.
Is a HECM or HELOC a Better Choice?
So is either of these a good choice for you? Let’s look at some of the pros and cons of both HECMs vs. HELOCs.
HECM Pros and Cons
If you’re strongly considering a HEMC, it’s likely because you’re a senior looking for financial security as you approach retirement. Aside from the ready access to home equity, your interest may be peaked by HECM benefits like the following:
- Secure borrowing
- Financial flexibility
- No more monthly mortgage payment
- Retention of the title to your home
However, some of the cons that can come with a HECM include:
- Higher loan origination fees
- Loan payment falls to your heirs when they sell your home
Keep in mind that you may not be eligible for a HECM loan. If you aren’t, you may find yourself considering a HELOC.
HELOC Pros and Cons
A HELOC can be helpful in situations where you want to consolidate debt or cover major payments. The benefits include:
- Accessible line of credit for major expenses
- Flexibility in the amount you can borrow
- The borrowed amount can be refinanced
- Interest-only accrues on the money you use
However, some features make HELOC loans less than ideal for seniors approaching retirement. These include:
- Adjustable interest rates
- Lump payments at the end of the loan term or repayment period
- Potential to lose your home if you can’t make the monthly payment
- Perpetuation of the debt cycle if you need to borrow more to make payments
A HELOC isn’t the right choice for everyone. Carefully consider the terms and potential for consequences if you can’t make payments on time. If you are also seeking a HELOC with bad credit, a HECM might be a better option for you. There is no minimum credit score so you will have an easier time getting approved than you would for a HELOC.
A Better Alternative to Both HECM and HELOC
If neither a HECM nor HELOC meets your needs, don’t worry. Other alternatives don’t require you to make payments, pay hefty fees, or leave your heirs with a home to sell upon your death.
A sale-leaseback program may allow you to do so while you stay in your home. Through a sale-leaseback solution, you can sell your home to and convert your home’s equity to cash. Then, you can lease your home back for as long as you’d like.
What is the best way to access and use equity? Two common approaches are a home equity conversion model (HECM) and a home equity line of credit (HELOC). After comparing HECM vs. HELOC, if you are still unsure of alternative options to access equity from your home after reading this article, consult a financial advisor to discuss your options.
- HUD. Home Equity Conversion Mortgages for Seniors. https://www.hud.gov/program_offices/housing/sfh/hecm/hecmhome
- Federal Trade Commission. Home Equity Loans and Credit Lines. https://www.consumer.ftc.gov/articles/0227-home-equity-loans-and-credit-lines