So we thought we would take a look at the pros and cons of both and how you can combine both into a product that we call the ‘Reverse Mortgage Line Of Credit (RM-HELOC)‘.
Basic Background To These Products
Before we start, let’s quickly recap exactly what is the difference between these products.
- Reverse Mortgages: First off, the name can be a confusing term. Most people, when they hear of this for the first time, think that they must just be another standard mortgage – you stake your home equity against a debt to, most often, a bank. Usually you don’t have the value of your home in your account (otherwise you may just buy it outright if you so choose), so the bank is lending you money with the knowledge that they are in a position to take possession of the home should you fail to pay your debt. Well, in the case of this particular mortgage product, this isn’t how it works at all. It only takes into account the equity you have built up in your home, and at a maximum of 55% of the home value, lends you that amount (the exact amount depends on your age). You are always in possession of the home, and the bank is never able to claim the home.
- A Home Equity Line of Credit (HELOC), however, is structured like a conventional mortgage. That means, should you fail to repay the loan or meet the loan requirements, you may be forced to foreclose on your home – i.e. the bank takes possession.
While the reverse mortgage can be structured in a number of ways, the idea remains the same. You are always in possession of your home. We’ll take a look at other ways to take out your money (whether lump sum, monthly installments, as a line of credit, or a combination of these), but in this article, we’re going to focus on the RM-HELOC of credit option to draw a direct comparison to a HELOC.
The ‘Reverse Mortgage Line Of Credit (RM-HELOC)’
This is the name for a product where you essentially turn it into a Home Equity Line Of Credit.
By voluntarily paying the interest each month on your mortgage you have effectively turned it into a HELOC – this is the ‘RM-HELOC’
The key word here is voluntarily – all payments you make are voluntary, where as under a Home Equity Line Of Credit you are required to make the payments every month.
Why Would You Choose A ‘RM-HELOC’ Over A HELOC?
Aside from the fact that your payments are voluntary – as mentioned above – there are many other reasons to choose this product.
One of the main differences right from the get-go is the qualification requirements between the two.
HELOC borrowers must qualify based on their credit and income. A ‘RM-HELOC’ is based just on age and that you own your home.
These qualification requirements for the HELOC can be a challenge for retirees, especially if they don’t have a strong income, have a low credit score, or have a higher debt ratio.
The RM-HELOC allows retirees to access their home equity when it’s needed so they can pay off bills, supplement income, settle debts, or even simply enjoy their retirement.
The idea behind it is that you’ve worked hard to build up your home equity, so you should be able to access it in a way that is tailored for retirees.
It is important to note that both HELOCs and RM-HELOC require that you keep up to date with your property taxes.
What About Interest Rates?
Just now – at least for the time being – HELOC rates are lower than that of a reverse mortgage (although it is worth noting that they are variable – so they could go up). For more on this see our article on the latest rates:
However, again the key point here is the fact that making these payments is actually voluntary under the a ‘RM-HELOC’.
If you’re a little stuck one month, skip the payment. Want to go on vacation? Skip the payment. It is this flexibility and freedom that a RM-HELOC offers – the higher rate is the cost of this.
It is sometimes dangerous for retirees in a situation where they have no income to take out a HELOC versus a RM-HELOC due to the fact that they may in some cases have a ballooning debt as part of their HELOC and cannot make the monthly payments since they don’t have income.
Reverse mortgages are built solely for retirees, and allow you to access the equity you have built up in your home over your lifetime without having to worry about income monthly.
What About Home Equity And The Impact?
This has been mentioned, but it’s an important point, so we’ll return to it: when the loan becomes due, there can be a huge difference between a HELOC and a RM-HELOC.
Some HELOCs will allow you to take up to 80% of your home value out. While this value doesn’t usually become available to you since the lending requirements are often based on income and more, the important thing to note is how high the loan amount can get to.
A RM-HELOC in contrast, can only be for a maximum of 55%, and there is a good reason for this.
When the loan becomes due, should you move or the owners of the home pass away, your remaining 45% of your equity can be used to pay off this loan amount (and it is most common that homeowners don’t take out more than 50%).
The key takeaway is that you are a lot safer, and so is your family, should your loan become due when you can use your value of your equity, which tends to grow over the lifetime of the mortgage, to repay the amount outright.
In essence, a HELOC can actually be much more damaging to your home equity if you take out the full 80%.
Financial Stress And Freedom
A HELOC can cause severe financial stress should the loan become due and you do not have the value remaining, or the ability to access your remaining equity, to pay off the loan.
Banks can recall the HELOC loan at any time, for any reason. This is very, very rare and unlikely to happen but it should definitely be considered.
You may be forced to give up on your home to pay off your loan should it have grown to an amount as high as allowed by HELOCs – something you will never have to do in the case of a RM-HELOC.
In some cases, especially for short-term periods, a HELOC may be better suited for your financial needs. If there is a short-term debt you need to pay off, and especially if you have the income to pay the loan back quickly, then a HELOC may be the best option. However, for the long-term, and especially for retirees with no source of income, a reverse mortgage is generally the best choice.
In Conclusion: HELOC vs RM-HELOC
While a RM-HELOC doesn’t quite have the same ring to it as HELOC, there is no doubt in our mind it is a superior product for the following reasons:
- Your payments are voluntary – so you can pause them any time you like. This freedom and flexibility is massive.
- Because the payments are voluntary, the lender can never take your home for missing payments. Missed payments under a HELOC could see you put your home in jeopardy.
- The amount you can take out of your home is capped to 55% – as opposed to 80% – this works to help ensure you don’t over leverage on your home.
- You do not need any income levels or credit score to quality for a RMLOC; you do for a HELOC.
Yes, the interest rate is a little higher on a RM-HELOC. The question you have to ask yourself is: are all the above benefits worth paying a slightly higher interest rate to get?
As we have talked about before, there are many misconceptions about reverse mortgages (
click here to read our article with more on this). The above information should help guide you along the way.
I hope this article helped if you are thinking about a reverse mortgage – you should also check out our other article on the alternatives to a reverse mortgage for further information on the other options out there. If you have got any further questions regarding a RM-HELOC – please lease a comment below and we will answer them for you.
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A Canadian Chartered Accountant and licensed Mortgage Professional – creator of Reverse Mortgage Pros – the #1 reverse mortgage specialists in Canada. I make it my mission to educate Canadians about how reverse mortgages work so that you can make an informed and educated decision that’s right for you and your family.