What is the difference exactly, they both seem like the same thing.
A home equity loan is like a mortgage on the value of the house that you have either paid off or has appreciated over time. You are expected to pay it off eventually, and then have full equity again.
A reverse mortgage, if I understand the ads, is when someone has agreed to buy your house, with you living in it, and pays you the value of it over time. At the end of this period you are dead and they get the house. So, it is meant for the elderly who don’t have anyone to will the house to, or who don’t want to. I don’t know what happens to the balance of an existing mortgage, if any. I assume this is mostly for those who own their house free and clear.
I say the hell with both of them. I know home equity loans are efficient ways of paying off high interest credit card debt, but I wonder how many people stop overspending when they get one.
What?!? I know they seem to be advertised as this, but a home equity loan is an awesome tool for smart people, too. Like being able to use a cheap and tax-free capital of your house for just about anything. Cars. Remodelling. Tuition. Higher return investments. And yeah, even transferring from higher debt to lower debt. You could do all of these by refinancing your first, but a home equity loan is often free or very low cost, whereas if you want another first mortgage, you have all kinds of fees and title costs and so on to re-pay for.
In my case, I got a home equity loan at the time I bought my house so I wouldn’t have to make a down payment or pay rip-off PMI insurance. My average returns are better than the cost of the mortgages, so unless the economy gets bad again it’s a smart decision for credit-worthy people (who can afford the slight gamble).
People that truly have bad spending habits don’t often qualify for the teaser 4% rates these companies offer anyway, so they just trade one high debt for another.
Can you explain this in more detail, please? I thought that a home equity loan was a loan you could get on the net worth of your home after your mortgage. So how can you get one when you’re buying your house?
I thought a home equity loan was just based on the equity and you didn’t need 100% of the equity to get a loan. I also think you can get 125% of the value of your equity.
As for reverse mortgages, I still can’t tell the difference between them and a home equity loan. Is a home equity loan a loan where you still have equity in your house but a reverse mortgage a loan where you sell your equity outright but still get to keep your house until you die?
OK, here’s two examples. We took out a home equity loan and used it to make improvements on the existing structure. The loan collateral was the equity in the property. The interest was relatively low, and at the time was also tax deductible, which made the actual amount paid really low. At the time we had no other mortgage, but if we’d had one, we could have gotten the H.E. loan as a second mortgage. Obviously, we could not have borrowed more than the open market value minus anything owed on the first mortgage. Over time we paid it off and the house was once again unencumbered. Had we died before paying it off, that debt, like any other debts existing at the time of death, would have been required to be paid off out of our estate, if any.
My elderly father took out a reverse mortgage in the form of a line of credit against the value of his house. He got money from the R.M. company as he needed and wanted it. An alternative would have been to borrow a specific amount and keep it to use as needed. There was no intention and no expectation of his ever paying it back during his lifetime. The lender had a lien on the property. When my father died, there was an encumbrance of several tens of thousands of dollars. My sister and I advised the R.M. company that we intended to sell the property on the open market. When the sale went through, the first payment from the closing was to pay the balance owed (which included interest and fees) to the R.M. company. We got the pittance that was left. If we had not sold the property promptly, the R.M. company would have repossessed it.
Anecdotically, the longest living woman, Jeanne Calment, who died at 122 or so, had signed such a contract with an estate lawyer. Since she was already quite old, the payments (based on the value on the house and life expectancy) were rather high. When she became the oldest person in France, then in the world, the story was widely reported, and the lawyer made fun of. When the poor guy eventually passed away, in his 80’s or 90’s IIRC, the story was so widely know that his death was announced by the medias. He had paid to Jeanne Calment, who outlived him, way more than her house was worth, but never got to live in it.
You got it perfectly right. Unless you use the VA guaranty (which I couldn’t because my guaranty’d house hadn’t sold yet) or come up with 20% down, you’re normally stuck paying PMI – that’s mortgage insurance in case you default. So to avoid this stupid little useless fee that does nothing for you, and to avoid actually putting money down, the first mortgage is taken at 80% – hence no PMI, not VA guaranty needed, and nothing. Take out a home equity loan (same thing as a second mortgage) for the remaining 20% (the equity beyond the 80%), and you have 100% financing without any of the elevated interest rates or PMI payments. Oh, another thing I always tend to forget about VA is the “funding fee” which would have been 2% of the purchase price additional.
A reverse mortgage is a loan to an elderly home owner on which the balance rises over time, and which is not repaid until the owner dies, sells the house, or moves out permanently.
To get one, you have to be at least 62. And as the definition indicates, the balance increases over time. This is because you don’t make payments on a reverse mortgage. Either you get payments from the mortgage company, you get a line of credit from the mortgage company, or the mortgage company pays off your conventional mortgage and you get to live in the house without making mortgage payments. These options are attractive to those with fixed incomes.
Some of the advantages to a reverse mortage are:
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As mentioned, no more mortgage payments. You still have a mortgage, but you don’t pay it. Instead it accrues interest and grows, which means your equity shrinks.
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A source of credit or cash. There are reverse programs that offer monthly payments or lines of credit. The money is tax free because it is proceeds of a loan.
OTOH, some disadvantages are:
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You can’t have anyone under 62 on the title. If married someone 20 years younger, you will have to removed them from the deed. Ditto your kids.
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Heirs apparent sometimes see a reverse mortgage as squandering their inheritances.
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The borrower is still responsible for taxes and insurance and keeping the house up. If they don’t pay the taxesl, or repair the roof, the mortgage servicer will foreclose.
Because the programs are intended for elderly people, and because the get pretty complicated, applicants are required to attend counseling before they can get one.
You can find more information than you need at:
http://www.hud.gov/buying/rvrsmort.cfm
Home equity loans are just second mortgages. You take one out, it gets second position behind your first mortgage. As you make payments, and as the value of the property appreciates (we hope), your equity increases. This is the key difference reverse mortgages eat equity over time–home equity loans allow equity to increase over time.
A great site for information on mortgages and the mortgage industry is
That’s fine for one time expenses, which shouldn’t be on a credit card in the first place. But with an average of $7k credit card debt, I wonder how many people are considering home equity loans free money - that’s the way they are advertised. Someone spending more than they are making are going to be spending even more in interest charges, without the brake of being close to their credit limit. Bad spending habits seem to be the norm, and the way the credit card industry makes its money.
It can definitely happen that way. Many people pay off their credit cards with a refi or a home equity loan and then run up additional credit card debt. But used intelligently, a home equity loan can be a good deal.
This is a complicated question whose answer depends on a number of factors. Here is a good discussion of the issues:
http://www.mtgprofessor.com/A%20-%20Refinance/Cash-out%20Refi%20or%20Home%20Equity%20Loan.htm
Bathisar sorry I’m kinda slow but I’m confused. The remaining 20% (the home equity loan) - doesn’t that use as collateral your “home equity”? So if you have a NEW morgage for 80% doesn’t that mean that you have zero equity in the house to be loaned against?
Not really. Bank #1 is willing to put their faith in you to loan you 80% of the value of your house at a certain rate. Bank #2 (who may actually be the same as Bank #1) is willing to put their faith in you to loan you 20% of the value of your house at a slightly higher rate. So you have zero equity, but only because you’ve taken out both loans. Bank #1’s risk is at 80%, which it’s comfortable with, and it’s risk doesn’t increase because you’ve borrowed against the other 20.
Two mortgages. One uses 80% of the equity as collateral. The “home equity” loan uses the remaining 20%. A common reason for this setup is to avoid private mortgage insurance, or PMI. On most mortgages that use more than 80% of the equity in a home, the borrower must buy PMI. PMI premiums are not tax deductible, but interest payments on a second mortgage are. Therefore, a broker or loan officer will often suggest taking out a first mortgage for 80% of the value of the home, which avoids the PMI requirement. The remaining funds are borrowed as a second mortgage. In the industry these are called 80/20s, 80/10/10s, or piggyback loans.
Here is a good discussion of the topic:
http://www.mtgprofessor.com/A%20-%20Second%20Mortgages/can_two_mortgages_cost_less_than_one.htm
Kind of. Bank one is going to have to approve the fact that you’re taking out a home equity loan on top of a 1st mortgage. You’d better have really good credit and income, because while bank one’s risk is 80% of the loan value, the risk that it will see absolutely no money if you default is higer than if you put up the 20% yourself. As an aside, every time you try to take out a HELOC or a 2nd mortgage, you have to notify the primary lender, and subordinate that other loan so that it will wind up in second position when you record it at the courthouse. Anyway, more common than an 80/20 is a 80/15/5. 1st at 80%, 2nd at 15% and you come up with the additional 5%. That 5% is a good faith that you were at least able to come up with some money. It also goes along with good credit in showing that you are responsible… you can pay your bills on time, and save money at the same time.
Also kind of. Yes it’s in second position, but it’s not necessarily the same thing. If you do an 80/20 that 20% will most likely not be a HELOC, but a second mortgage. The key difference being that a HELOC will get you a spiffy 4% interest rate or so, while your second will most likely run you anywhere from 9-12%.
Right. The point of the 80/20 is so that if you default and they sell your house they have a buffer to make sure that they don’t lose any money. PMI also covers this buffer. Thats why I had a hard time understanding why when a 80/20 is considered proper any bank or banks would allow that zero equity situation, because if the house had to be liquidated and they recieved less that was loaned for it was be a ( practically) unrecoverable loss. I’m very curious about these arrangements because even though I am educated in finance I didn’t learn much about morgages in practice and I might be in the market for a home soon…
Well, it depends. The first may have some sort of adjustment to it that gets the bank more money either over time, or right up front. This would be in the form of points or a higher interest rate.
The second is usually always at a much higher rate. Since it’s a low amount of money, it’s not a huge risk for the second bank, and they’re recovering plenty of interest in the first few years of the repayment due to the high interest rate.
As for how they can do this? It’s all a statistics game. Don’t forget, you may wind up paying points on your loan if you go the 80/20 or 80/15/5 route. If the points are in the form of what’s called a level adjustment, the money from the points goes straight to Fanny Mae, not the Mortgage Company doing your loan. This money sits in a pool, and is a buffer for the amount of times that a 100% loan defaults within the first year or so. This system allows yet another segment of people to qualify for homes and make more money for the Mortgage Industry while at the same time minimizing the risk. And in case you’re doing some math and thinking it doesn’t add up right, I’ll save you the question.
How do you pay points when you already have 100% of the equity taken up, and you can’t put any money down? Well, answer #1 is a higher interest rate instead of the points. Answer #2 is a 103% or 105% loan… which do exist, but have strict credit limits. And answer #3 is you are generally allowed to accept a gift from an immediate family member to cover some costs. This is also why I said above that 80/15/5’s are more common… it involves you putting up at least some money.
Just rereading on preview… an 80/20 is where you get a first at 80% and a second at 20%. I think you were referring to an 80/20 as where you put up 20% and just plain get a loan. Confusion of terms, I think.
In my case, the 20% part is a HELOC, and interest-only at that (although I pay it as if it were a 10-year fixed rate). Have a nifty little “checkbook” I don’t plan on using or anything.
As to why the bank is willing to take a risk like that? It’s the reward for having a sterling credit history. No, it’s not “richness” (else I’d be able to plop down the cash, right?). Also the “zero equity” at closing is kind of a myth, too. We got the house under market in a booming area. If I were going to buy something in the city limits of Detroit (the still declining parts), the banks’d probably have something else to say about the matter.
Also, what’s the difference between zero equity at closing, and zero equity five years later when used to pay off credit card bills? I guess you could argue that you’re “established” in your home and therefore less risk, but on the other hand, we were already homeowners so at least established in life.
There is no standard for the use of the term home equity loan. Some lenders like to cash in on the currency of the term “home equity” while selling an ordinary second mortgage. Others reserve the term for Home Equity Line of Credit or HELOC. Yes a HELOC is very different from an ordinary mortgage, it is an open-ended line of credit.
Here are examples of popular sites that uses the term home equity loan to mean second mortgage. . .
http://www.rockfinancial.com/lpcontent/CnUtPage/rck/rck_3col/rck_hec_art_best_loan.en.html?heqart1
Note that they discuss home equity loans *and *lines of credit.
Right, which is why I said “kind of” and “not necessarily the same thing.” While you can most certainly use the term 2nd mortgage all you want, I just want people to realize that if they’re looking to buy a home, and they’re looking to do 100% financing, they better understand the difference. I mean, all mortgages are home equity loans if you want to get picky.