HELOC versus reverse mortgage: which is better for the average Canadian homeowner?

As some of my clients – or my clients’ parents – enter retirement, I’m often asked what I recommend as the best way to access home equity. There are two main products for this: the home equity line of credit (HELOC) and the reverse mortgage. As with many financial solutions, there are pros and cons to each product. Which is better for you depends on your specific circumstances. Here’s an overview of the key differences between these two financial products, and some tips to help you decide whether you’re better off with a HELOC or a reverse mortgage.

What is a HELOC?

In the financial industry we do love our acronyms. A home equity line of credit, usually referred to as a “heelock”, is a revolving line of credit. It’s secured by the equity in your home. Here are some features of the product:

Flexibility:

With a HELOC, you can borrow up to 65% of your home’s market value. As for payments, you only pay interest on the amount you’ve borrowed. This makes it a flexible option for people who need access to funds at different times.

Interest rates:

HELOCs typically have lower interest rates compared to unsecured loans, but the rate is usually higher than for fixed or variable mortgages. The rate is usually expressed in connection with the prime rate, for example, prime plus 1/2%. Because the rate is connected with the prime rate, it changes when the prime rate changes, so your payments also change along with the prime rate.

Payments:

Your minimum payment is the interest payable on the amount you have borrowed, each month. If you like, you can make extra payments to pay off some or all of the principal each month. If you don’t pay extra, your principal balance continues to accrue interest.

Do you qualify for a HELOC?

You need to be able to qualify for a HELOC in the same way that you would qualify for a traditional mortgage. It’s based on your income, credit score, and qualification ratios.

Who is a HELOC best for?

Ideal if you need flexible access to funds and have sufficient cash flow to manage monthly interest payments. It’s suitable for retirees who want to stay in their home, and are still earning an income, or have reliable pension and / or investment income, and have good credit.

What is a reverse mortgage?

A reverse mortgage allows homeowners aged 55 and older to borrow up to 55% of their home’s appraised value. Here are some key features of this product:

Flexibility:

You can receive the approved amount as a lump sum, in regular amounts, multiple lump sums as you need them, or a combination of these. The maximum amount you can borrow is calculated based on your age – the older you are, the more money you can get, and your home’s market value, property type – condo or detached home, and property location – if you’re in a major urban area, you can access more equity than if you’re in a small rural area.

Payments:

You don’t have to make any payments whatsoever, unless you wish to. Unlike with a HELOC, you don’t need to make regular payments – or any payments – on a reverse mortgage. If you like, you can make principal payments once a year or on some other schedule, but there is no minimum. The mortgage gets repaid when you sell your home, move out, or pass away.

Interest rates:

Unlike with a HELOC, the interest rates can be set for periods of time, similar to the terms you might select for a traditional mortgage. Because no payments are required, the rates are higher than with traditional mortgages, but quite similar to HELOC rates. Currently the 5 year fixed reverse mortgage rate is about 1/2% less than typical HELOC rates, while the 3 year fixed reverse mortgage rate is about 1/2% higher than typical HELOC rates.

Are you eligible for a reverse mortgage?

The main factor reverse mortgage lenders consider in figuring out if you qualify for a reverse mortgage is your age. You and anyone else on your property title must be at least 55 years old. The calculation of how much you qualify for is based on the youngest person on title. What does not factor in is how much money you make. Since payments are not required, the lender doesn’t need your income numbers for you to qualify.

Who is a reverse mortgage best for?

This option is best for retirees who need access to funds without the burden of monthly payments. It’s a good option if you plan to stay in your home for the long term but don’t have the cash flow or credit score to qualify for a HELOC or a traditional mortgage.

Conclusion

Both HELOCs and reverse mortgages are valuable tools for accessing your home equity. To determine which is the best option for you, I recommend evaluating your financial situation, future lifestyle plans, and research on both products, before making a decision. If you have any questions or need personalized advice, feel free to reach out. I’m here to help you make an informed decision about your financial future.

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