As a homeowner, chances are you’ve worked hard to build equity in your property — and if you’re facing a big purchase or unexpected financial need, it may make sense to convert that wealth into cash. But there are a variety of ways to go about it, each with their own benefits and drawbacks. In this article, we’ll walk you through the differences between a Home Equity Conversion Mortgage (HECM) and a Home Equity Line of Credit (HELOC), so you can determine which, if either, is right for you.
What Is an HECM?
Let’s take a look at HECMs first. An HECM is a type of reverse mortgage that allows homeowners aged 62 or over to take out a lump sum against the value of their home. (There are other types of reverse mortgages on the market that may be available to younger applicants, but these are privately offered and not backed by the Department of Housing and Urban Development, or HUD, as HECMs are. There’s also such a thing as an HECM for purchase, which helps those 62 and over finance a principal home.)
For some seniors, HECMs are especially attractive because the loan and its interest don’t need to be repaid until the last surviving borrower permanently vacates or sells the home (or dies). While there are usually upfront fees involved, for some borrowers, this arrangement can feel like free money.
However, because interest is building over time and not being repaid, HECMs can eat into the equity you’ve built in your home, which may be less than ideal if you’re planning to pass it on to an heir as an asset. Along with receiving a less valuable investment, your heirs will also be on the hook to pay the loan in full upon your death — or otherwise surrender the title to the lender.
What Is a HELOC?
A home equity line of credit, or HELOC, works differently than an HECM. A HELOC is kind of like a secured credit card, except it’s secured with your home’s equity. In fact, in some cases, it may literally come with a card — or a checkbook — attached to the account.
A HELOC allows you to borrow money against the value of your home, but doesn’t require you to take one large lump sum. Instead, you can borrow what you need through the HELOC’s draw period, and then repay it during the repayment period that follows. This arrangement may help some people borrow less overall, which in turn could mean paying less for the loan by way of interest. Some HELOC users borrow and repay money repeatedly during the draw period.
However, a HELOC is still a loan — and it still comes with costs. Some HELOCs allow borrowers to make interest-only payments during the draw period. However, once the principal comes due during the repayment period, the monthly payments will be much larger.
Key Differences
While HECMs and HELOCs are similar in some ways, there are some important differences that set them apart — and which may help you determine which is best suited to your needs.
Borrower Age Requirements
HECMs are only available to homeowners aged 62 and over.
HELOCs, on the other hand, don’t have any borrower age requirements — but they do have minimum equity requirements, and the lender will also check out your credit score and proof of income to qualify you for the loan. (Your credit history and other financial information will be part of the lending qualification decision for both HELOCs and HECMs.)
Collateral Requirements
Both HECMs and HELOCs are secured by your home, and you’ll need to have built up home equity in order to have value to borrow against.
Every lender has different specific requirements, but for a HELOC, you’ll generally need to own at least 15% or 20% of your home’s value. For an HECM, you’ll usually need to own a substantially greater portion of your home: 50% is a general rule of thumb, and some lenders may require you to have even more equity than that.
Repayment Requirements
Finally, as discussed above, there are substantial differences in HECM vs. HELOC repayment policies.
HECMs have upfront costs, but the loan principal and interest don’t come due until after the last surviving borrower sells the property, permanently moves out of the home, or dies.
HELOCs, on the other hand, are split into a draw period and a repayment period. During the draw period, when you can borrow against your home’s value, you may be able to make interest-only payments; both principal and interest will come due in the repayment period. The draw period is often 10 years long, and the repayment period may be another 10 or even 20 years.
Pros of an HECM
So, what are some of the benefits of a reverse mortgage?
• Money up front with no interest until later. For seniors who are planning to live in their home until they die — and don’t necessarily want to pass the property on to heirs — an HECM can provide an additional income stream that doesn’t require repayment during their lifetime.
• HECM funds aren’t taxable. Because money you borrow with an HECM isn’t considered income, you don’t owe income taxes on it.
Cons of an HECM
And now, some HECM drawbacks:
• You’ll decrease your home’s value as a personal investment. Because an HECM is borrowed against your equity and repayments don’t begin until after you move out or die, it will decrease the value of your property as an investment for you and your family.
• You’ll probably still have to pay upfront fees. Even for those who see HECM funds as “free money,” origination fees and other upfront costs can still add up to a sizable amount.
• Your home could be foreclosed if you fail to make other payments. Property taxes, homeowners association fees, and homeowners insurance premiums will all still be due regularly, and if you don’t pay them, your HECM lender could take possession of your home.
• Your heirs may face a challenging decision. If you don’t repay your HECM during your lifetime, your heirs will either have to repay the loan in full or surrender the property to the lender — and they’ll be forced to make that decision fairly soon after your death as the transaction typically needs to happen within one to six months.
Pros of a HELOC
Now, let’s take a look at the best reasons to consider a HELOC in the question of HECM vs. HELOC.
• Lower interest rates than other forms of credit. Because a HELOC is secured by your home, it may offer lower interest rates than comparable types of loans like unsecured credit cards.
• Borrow only what you need. HELOCs allow you to flexibly borrow only what you need during the draw period, rather than taking out a lump sum.
• HELOC interest may be tax-deductible if you are using the funds you borrow to make improvements on your home.
Cons of a HELOC
There are drawbacks to HELOCs, too, to be aware of. For instance:
• Variable interest. Most HELOCs have variable interest rates, which means your monthly payment can be unpredictable as market conditions change.
• Decreased equity. Like any loan taken against your home’s value, a HELOC can decrease the amount of equity you own — which in turn decreases the value of your home investment (until the loan is repaid).
• HELOCs open you up to foreclosure. If you fail to make your HELOC payments, the lender can foreclose on your home (even if you’re still making payments on your primary home mortgage loan).
HELOC vs HECM: Which Option Is Better?
In the end, only you can determine which of these loans makes the most sense for your personal situation — or if it would be better to find another way entirely to meet your financial needs. Both HELOCs and HECMs put your home on the line and decrease the equity you’ve worked hard to build in your property.
For those age 62 and over who are eligible to apply for an HECM — and who don’t plan on leaving the home to heirs — a reverse mortgage could offer access to cash without many costs in the short term.
For those who are looking for a more flexible way to borrow against their home equity, a HELOC may help you convert your home value to cash at a lower interest rate than other types of loans. However, variable-rate interest can make payments unpredictable, and if you choose interest-only payments during the draw period, you may be stuck with much higher bills later on when repayment comes due.
The Takeaway
HELOCs and HECMs can help eligible borrowers use the value they’ve built in their home to their advantage by converting some of it to cash in the short term. However, both are forms of debt, and therefore costs and risks are involved. One major advantage of HELOCs is that anyone with sufficient equity in their home can apply for a HELOC, whereas HECMs are only for those age 62 and over.
SoFi now offers flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively low rates. And the application process is quick and convenient.
FAQ
What are the differences between HELOC and HECM?
An HECM is a type of reverse mortgage. It is a loan available solely to homeowners aged 62 and over. With an HECM, the principal and interest payments don’t become due until the borrower moves out of the home or passes away, which can make them attractive for some seniors (but challenging for those hoping to pass on the home to heirs). A HELOC, on the other hand, is a more flexible line of credit that allows you to borrow money as needed, up to the maximum amount you qualify for, against your home’s equity. Unlike HECMs, HELOCs do not have age eligibility requirements.
What are the downsides of an HECM loan?
HECMs lower the equity you own in your home, and since interest and principal are building up unpaid over time, the value of your ownership can decrease dramatically over the course of the loan’s lifetime. Furthermore, the entire sum of the loan becomes due when the last surviving borrower vacates the home or passes away, which means your heirs will need to pay up — or they will forfeit the property to the lender.
Is there an age requirement for a HELOC?
Unlike HECMs, HELOCs do not have age requirements. However, your lender will still assess your creditworthiness, and there are also minimum equity requirements to ensure you own enough of your home’s value to borrow against.
Photo credit: iStock/VioletaStoimenova
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