HELOC vs. Reverse Mortgage (Frequently Asked Questions)

Posted by Charles D

November 26, 2008

active seniors

There is a difference between a HELOC and a Reverse Mortgage, although to the average consumer they seem pretty close. Bankrate, does a fabulous job explaining the difference.

A reverse mortgage is an interest-only loan that capitalizes the interest expense along with the principal. That means that there are no loan payments at all until the note comes due. The loan balance grows with the interest expense added to the cash payments made to the homeowner.

Events that could cause the lender to call the note, depending on the note’s terms include, moving out of the house and selling the home or upon your death. The home doesn’t have to be sold when the loan is called — the lender just needs to be paid. The National Reverse Mortgage Lender’s Association describes the process of getting a reverse mortgage in this pamphlet.

Depending on how you structure the loan, you can get a lump-sum at closing, use the reverse mortgage like a line of credit, receive a regular cash distribution, or some combination of these actions. You indicate in your letter that you’re interested in a reverse mortgage with a line of credit.

There are three types of reverse mortgages, categorized by the insurance provisions on the loan: FHA insured, lender insured and uninsured. The Federal Trade Commission has an online brochure that describes the differences in the three types of reverse mortgages.

These mortgages are very attractive to retirees because they don’t have to find room in their household budget to make loan payments while tapping the equity in their homes. They pay a price for that convenience because of the additional risks to the lender (or insurance company) on this type of loan.

Let’s assume that you expect to need an average of $500 a month, or $6,000 a year, from a credit line. The minimum required monthly payment on a home equity line of credit, or HELOC, is typically the interest expense on the balance. Make the assumption that you draw on the line to both meet your needs for income and to pay the monthly interest expense, and you’ve got a loan balance that grows much like a reverse mortgage. The table below shows a comparison between the two loans assuming a $500 a month draw on the credit line and a 1 percent difference in interest rates on the two loans.

Reverse mortgage, HELOC comparison
Home’s market value $450,000		Current HELOC $112,500

		Interest rate	Closing costs
Reverse Mortgage	$168,750	7%	$11,000
Expanded HELOC	$168,750	6%	n/a

Year ($500 a month draw)	Reverse mortgage ending loan balance	HELOC ending loan balance	Difference in loan balances
1	$17,980	$6,180	$11,800
2	$25,449	$12,731	$12,718
3	$33,440	$19,675	$13,765
4	$41,991	$27,035	$14,956
5	$51,140	$34,837	$16,303
6	$60,930	$43,107	$17,823
7	$71,405	$51,874	$19,531
8	$82,613	$61,166	$21,447
9	$94,606	$71,016	$23,590
10	$107,439	$81,457	$25,981
11	$121,170	$92,525	$28,645
12	$135,861	$104,256	$31,605
13	$151,582	$116,692	$34,890
14	$168,402	$129,873	$38,529
15	$186,401	$143,845	$42,555