We get it. Deciphering mortgage terminology is like solving a Rubik’s Cube sometimes! You just want to throw your hands up in the air and say, “I give up! Somebody else figure this out for me!”
That’s what I am here for – to answer your most complex and confusing questions about the mortgage industry.
Today’s topic of confusion: The difference between a home equity line of credit (HELOC) and a type of reverse mortgage, a home equity conversion mortgage (HECM). Though at first they seem to be very similar types of loans, they are in fact, quite different.
How Are They Similar?
With both a HELOC and a HECM, you use the equity in your home for other financial purposes. As a reminder, “equity” is the difference between what you still owe on your home and how much it is worth. For example, if your home is worth $500,000 but you only owe $100,000 more on it, you have $400,000 of equity in your home. That’s your money! You’ve invested it; it’s up to you what to do with it.
The main differences come in with who is eligible, how the equity is used, and how it is paid back.
What Is A HELOC?
A home equity line of credit, or HELOC, is a form of credit in which your home’s equity serves as collateral. Because a home is often an individual’s most valuable asset, many use HELOCs only for major items, such as education, home improvements, or medical bills, and not day-to-day expenses.
HELOCs are available to any homeowner, regardless of age, with enough equity in their home.
To start, you will be approved for a specific amount of credit. The credit limit on a HELOC is generally set by taking a percentage (not the total) of the home’s appraised value and subtracting from that the balance owed on the existing mortgage.
Your lender will then review your ability to repay the loan (principal and interest) by looking at your income, debts, and other financial obligations as well as your credit history. Many plans set a fixed period during which you can borrow money, such as 10 years. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period (the “repayment period”), for example, 10 years. Once approved for a HELOC, you will most likely be able to borrow up to your credit limit whenever you want. Typically, you will use special checks to draw on your line. Under some plans, borrowers can use a credit card or other means to draw on the line. There may be other limitations on the plan, such as keeping a minimum balance in the account.
What Is A HECM?
A home equity conversion mortgage, or HECM, is a federally approved type of reverse mortgage that allows older homeowners to borrow against the equity in their homes.
It is called a “reverse” mortgage because, instead of making payments to the lender, you receive money from the lender. The money you receive, and the interest charged on the loan, increase the balance of your loan each month. Over time, the loan amount grows. Since equity is the value of your home minus any loans, you have less and less equity in your home as your loan balance increases.
This plan can gives some older Americans financial security after retirement. It assists them with making home improvements, offsets unexpected medical expenses, and supplements Social Security or other income.
Not everyone is eligible. To qualify for a reverse mortgage you must be at least 62 years old, be the primary resident and paid off some, or all, of your traditional mortgage.
There is generally an origination fee and other closing costs, as well as servicing fees over the life of the mortgage. You may also be charged mortgage insurance premiums (for federally insured HECMs).
Once you sell your home, move out, or pass away, the loan must be paid back in full. In most cases, the home is sold to get the money to repay the loan. Once the loan balance is paid, you or your heirs can receive any proceeds above the balance of the loan.
I hope this helps clear up some confusion about these two different ways to use the equity in your home. If you have more questions, feel free to call anytime – 503-654-7369!
Source: Consumer Financial Protection Bureau