So, you’ve decided you want to access your home equity for a renovation, big purchase or to help a family member out. But what is the best method of accessing your home’s equity?
Two options are to use a home equity loan, and for some, a reverse mortgage. We discuss what these are and the key differences here.
Home equity explained
Home equity refers to how much money you own in your home. The exact way to calculate home equity is to take your remaining mortgage balance away from the current value of the property.
Imagine your home is currently valued at £250,000 and you still need to repay £125,000 of your mortgage. That would mean you have £125,000 home equity (£250,000 – £125,000). It’s crucial that you use the current property value rather than the purchasing price. Property value can increase and decrease, meaning so can your equity.
What is a home equity loan?
Lenders will offer loans relating to how much home equity you have, aptly named a home equity loan. They will usually offer up to 85% of your home equity as a loan, meaning if you have £100,000 equity then you could get as much as £85,000. However, the loan will still be subject to financial checks, including your credit score.
A home equity loan uses the home equity as collateral in the event you fail to keep up with loan repayments. If you fall behind and are unable to repay what you borrowed, the lender could use foreclosure to get their money back. Foreclosure is when you are forced to sell your home to raise funds. From the sale money, the mortgage lender and the home equity loan lender should be able to recover the debts.
Is a home equity loan the same as a reverse mortgage?
Home equity loans and reverse mortgages have some similarities but they are not the same. They both allow the homeowner to access home equity, but the way the equity is repaid is entirely different. Moreover, a home equity loan is used by people who still have a mortgage, whereas a reverse mortgage is used by people above a certain age and own their home outright with no existing mortgage.
So, what is a reverse mortgage?
A reverse mortgage is the opposite of a forward mortgage to buy a property. It can be used by outright homeowners who are over 55 years old and spend at least six months of every year in the UK. A reverse mortgage allows the homeowner to access a high percentage of their home equity as a lump sum payment, through monthly instalments or a line of credit.
For example, if you owned a £300,00 home outright, you could use a reverse mortgage to receive a lump sum payment of potentially up to £250,000. The recipient would not have to pay any of this money back until they:
- Pass away, in which case it should be paid from their estate
- Sell their home, in which case the money will be paid from the property sale
- Leave the UK (usually)
Lenders are required to provide a reverse mortgage responsibly by not enabling too much equity release. If they allowed the homeowner to access too much equity and the home decreased in value, it would need to be paid from the person’s estate.
The difference between reverse mortgage and home equity loan
The two important differences between a home equity loan and a reverse mortgage are:
- Eligibility – Anyone with home equity may be eligible to apply for a home equity loan whereas to be eligible to apply for a reverse mortgage you must own the property outright, be at least 55 and live in the UK for half of every year.
- Repayments – home equity loans are repaid soon after the loan is taken out, usually ongoing each month. These repayments include a fixed amount plus a fixed interest rate. But a reverse mortgage includes no ongoing repayments. The mortgage is only repaid from the homeowner’s estate when they die or from the sale of the property.
Reverse mortgage vs home equity loan
If you have been wondering whether to use a home equity loan or reverse mortgage, the eligibility criteria may decide for you. A reverse mortgage includes stricter criteria and you may not be applicable for this home equity option.
But if you are eligible for both, how do you know which one to choose? The best move is to get professional advice.
A reverse mortgage is a great option if you don’t have a lot of money but do own a home and want to retire early. However, one of the key considerations will be your family and estate beneficiaries.
If you want to leave them your home then a reverse mortgage will not enable this to happen as it would be used to repay the money. Although, if you were to die with a home equity loan, the lender can also ask estate beneficiaries to pay the money back.
Can I take out a home equity loan if I have a reverse mortgage?
It’s probably not possible to take out a home equity loan if you already have a reverse mortgage unless you have sufficient equity left in the property. You may be able to switch your reverse mortgage to another home equity release product instead.
Reverse mortgage vs HELOC
A home equity line of credit (HELOC) is similar to a home equity loan but the money is not paid out in a lump sum and generally does not have a fixed interest rate. Instead, the equity is paid out similar to using a credit card over a “draw period” of many years. A HELOC is available to anyone with home equity just like a home equity loan – subject to lender approval.
Reverse mortgages are also able to be paid out in this way using a line of credit where the homeowner decides how much they want to draw at certain times. And reverse mortgages can sometimes be approved with a fixed monthly payout.
Read more about making the most of home equity!
For more information on accessing home equity, consider speaking with professional finance advisors, free money advice groups and read more of our guides. We’ve just released scores of new home equity guides just for you. Happy reading!