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Reverse Mortgage, Home Equity Loan, HELOC: What You Need to Know

Whether you're renovating your home, supplementing your retirement income or making big purchases, you have options to access money from your home equity.

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According to a 2022 study from Gallup, 52% of Americans are increasingly worried about maintaining the standard of living that they enjoy. However, there’s a positive piece of news for their personal finances if they own their home: Their home equity has likely soared. 

Recent data from CoreLogic shows that American homeowners gained a collective $1 trillion in home equity at the end of 2022 compared with the end of 2021. That’s already on top of a surge in home equity as the low rates of the pandemic fueled an insane housing market and large jumps in valuation in most parts of the country.

If you’re one of the many homeowners who are sitting on a sizable chunk of equity, there are a few different ways to borrow against your home’s value to help you pay for major expenses, consolidate debt, cover part of your retirement or renovate your home.

Before you make any moves, however, it’s important to recognize that borrowing against the value of your home isn’t something to be taken lightly. You’re putting your home on the line, so proceed cautiously. As you compare your options, here’s a rundown of what you need to know about the differences between a reverse mortgage, a home equity loan and a home equity line of credit, or HELOC.

What is a reverse mortgage?

Appropriately named, a reverse mortgage operates in the reverse direction of a traditional mortgage. Instead of making payments each month to pay down your principal, you’ll receive a check each month (there are also options to borrow in one lump sum), and you won’t have to make payments until you sell the home or you die. This isn’t for everyone, though. You need to be at least 62 years old to apply for a reverse mortgage.

There are also different varieties of reverse mortgages: single-purpose, which restrict the way you can use the money; home equity conversion mortgages, or HECMs, which are insured by the federal government; and proprietary reverse mortgages, which can have higher limits than government-backed loans.

Pros and cons of a reverse mortgage

Pros

  • No immediate payments

  • Multiple options to receive funds -- monthly payments or one lump sum

  • Ability for a spouse to remain in the home for up to 12 months after you move to a health care facility or (in most cases) die

Cons

  • Adds to your debt

  • Can create complications with passing on the home to your heirs -- and a 12-month remain period for your spouse is still a fairly short amount of time

  • Comes with high closing costs, including origination fees of up to $6,000 and annual mortgage insurance premium

  • Potential for scams -- bad actors are known to target older homeowners

  • Can still lose your home if you fail to pay property taxes or homeowners insurance

Takeaway

If you’re an older homeowner with a lot of equity -- at least 50% -- in your home, a reverse mortgage can be a smart pathway to accessing cash. These can come with serious consequences, though, for your spouse or what you pass along to your heirs, so it’s important to do your research and discuss the option with your family. You’ll have to complete a homeownership counseling course if you take out an HECM (a reverse mortgage backed by the US Department of Housing and Urban Development), which can help answer your questions.

What is a home equity loan?

home equity loan -- also often called a second mortgage -- lets you borrow based on the amount of equity you’ve accumulated in the home. Most lenders will only allow you to have a maximum outstanding mortgage debt of 85% of the value of the home (with some exceptions) between your first mortgage and the home equity loan. The loan is a fixed-rate loan, and repayment periods typically range between five and 30 years.

Pros and cons of a home equity loan

Pros

  • Fixed rate means your payments will never change

  • Money is distributed in one lump sum

  • Ability to deduct interest if you use the loan to improve your home

Cons

  • Must manage two mortgage payments, assuming you’re still paying off your first mortgage

  • Potential to be underwater on your mortgage if your housing value declines significantly

  • Often includes some additional closing costs, but this varies by lender

  • Typically requires very good to exceptional credit

  • Putting your house on the line is always risky

Takeaway

If you have a firm number in mind of the amount of money you need to borrow, a home equity loan can be a good option. You’ll need very good-to-exceptional credit to qualify for the lowest rates, though. 

What is a HELOC?

HELOC stands for home equity line of credit. While it has similarities to a home equity loan, a HELOC has a couple of key differences. First, it’s a line of credit instead of one lump sum. So, you’ll only draw funds as you need them during the so-called “draw period,” which typically lasts for 10 years. Second, a HELOC has a variable interest rate that moves either up or down based on market conditions. Your payments will fluctuate as the rate adjusts. Like home equity loans, you’re typically limited to a combined mortgage debt of 85% of your home’s value.

Pros and cons of a HELOC

Pros

  • Ability to make low payments that only cover the interest charges during the draw period

  • You can borrow as much money as you need

  • Often comes with a low introductory rate, along with potential interest rate discounts if you’re an existing customer

  • There are usually no closing costs

  • Some have the option to convert to a fixed rate, providing protection from rising interest rates

Cons

  • Variable rate can create unexpected surprises for your budget, which is already happening as the Fed continues on its path of rate hikes

  • Some lenders charge annual fees for a HELOC

  • May be charged a fee if you close the line of credit within a given timeframe (typically, you need to keep it open for at least 36 months)

  • Potential to lose your home if you can’t afford to pay it back

Takeaway

A HELOC is a great fit if you aren’t sure about how much money you’ll need, and you have a financial cushion in your budget to withstand a payment increase when your rate goes up.

Reverse mortgages, home equity loans and HELOCs, compared

Home loan typeClosing costsAge requirementsAdditional feesHow you can use the moneyTax benefits
Reverse mortgageYes, up to $6,000 of origination fees, plus other closing costsYes, must be 62 or olderAnnual mortgage insurance premium of 0.5% of the outstanding balanceRestrictions apply to single-purposeInterest isn’t deductible until the loan is paid off partially or in full
Home equity loanVaries -- often 2% to 5% of the loan amountNoneNoneAny way you wantAbility to deduct interest for home improvements
HELOCTypically noneNoneSome lenders charge annual fees and/or early closure feesAny way you wantAbility to deduct interest for home improvements

Reverse mortgage vs. home equity loan

If you’re older than 62 and trying to figure out whether a reverse mortgage or a home equity loan is a better fit, you’ll need to think about one big question: Do you want to pay the loan back now, or would you prefer that your payments be delayed until you move or pass away? The other key consideration is the type of reverse mortgage you’re hoping to use; if you qualify as a low- or moderate-income senior and want to use a single-purpose mortgage, you’ll be restricted in how you can use the funds.

Home equity loan vs. HELOC

When comparing a home equity loan with a HELOC, the biggest question involves whether you want the comfort of a fixed-rate payment that will never change or you’re OK with a variable rate. However, you might not have to choose. Some lenders are now offering the best of both worlds with HELOCs that allow borrowers to convert a portion or all of their loan from a variable to a fixed rate. Additionally, you’ll want to think about how the closing costs on a home equity loan stack up against any annual lender fees on a HELOC. While the upfront costs might look overwhelming, those fees can add up over time on a HELOC, too.

Home equity loan vs. HELOC vs. reverse mortgage: Which one is best?

There isn’t a simple answer when comparing a home equity loan versus a HELOC versus a reverse mortgage. Each one offers a different set of benefits for certain types of homeowners. As you compare your options for tapping into your home equity, consider this simple guidance to get started:

  • If you’re an older homeowner with a large amount of equity, a reverse mortgage is likely your best bet.
  • If you want the stability of fixed payments and you know exactly how much you need, a home equity loan is probably the route to take.
  • If you aren’t sure of how much money you’ll need to spend and you’re OK with changes in your monthly payments, a HELOC should be at the top of your list.

How does the current interest rate environment impact reverse mortgages, home equity loans and HELOCs?

No matter which option seems most appealing to you, it’s important to understand that reverse mortgages, home equity loans and HELOCs all share one common trait: They’re a lot more expensive than they were just a year ago. As the Federal Reserve has increased interest rates, all of these products have started to cost quite a bit more than they did in the low-rate peak of the pandemic. For example, fixed-rate reverse mortgages jumped from 3.45% in February of 2022 to 6.74% at the beginning of 2023.

Some experts predict that home equity rates will jump to 8.75% by the end of the year, which can make monthly payments look much different for someone who managed to lock in a rate of less than 6% in early 2022. Still, they’re all cheaper than credit cards and most personal loans.

The bottom line

There are pros and cons to consider with home equity loans, HELOCs and reverse mortgages, but the most important lesson to keep in mind is that all of these will increase your debt and create a heightened risk of losing your home to foreclosure. Make sure you read the fine print to fully understand the fees you’ll pay and the rules you’ll need to follow to maintain good standing on your loan.

David McMillin writes about credit cards, mortgages, banking, taxes and travel. Based in Chicago, he writes with one objective in mind: Help readers figure out how to save more and stress less. He is also a musician, which means he has spent a lot of time worrying about money. He applies the lessons he's learned from that financial balancing act to offer practical advice for personal spending decisions.
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