HECM vs. HELOC: which should you choose?

Homeowners often need to borrow against their home equity, often to pay major expenses such as home repairs, medical bills or their children’s education.

Homeowners often need to borrow against their home equity, often to pay major expenses such as home repairs, medical bills or their children’s education. Several types of home loans are available, making it challenging to determine the best choice. A Home Equity Conversion Mortgage (HECM) and a Home Equity Line of Credit (HELOC) may appear quite similar at first glance since both are lines of credit that use the value of your home as collateral.

However, there are substantial differences between these two types of home loans that can make one preferable to the other, depending on your financial situation and other personal factors. The following information will help you choose between a HECM and a HELOC.

Let’s talk about a HECM, first.

HECM

A HECM, also known as a reverse mortgage, is available through HUD-approved lenders and insured by the Federal Housing Administration (FHA). HECMs are specifically designed for older homeowners, who must be at least 62 years of age to qualify. These homeowners typically have a significant amount of equity in their home and need to convert part of it into cash—often to pay off a primary mortgage.

A HECM allows you to begin drawing on funds at closing and as your financial needs arise. Lenders can structure HECMs to provide borrowers with automatic monthly payments for a specified period of time, which can be for as long as you live in the house. You aren’t required to repay a HECM if you move out of the house permanently, nor will your estate have to repay the loan when you pass away.

One thing to keep in mind about HECMs is that they are limited to those 62 and older, meaning it’s not an option for younger homeowners. Older homeowners have both options at their disposal, so they are the ones for whom these comparisons will be most useful. Another thing to note is that while interest rates on both HECMs and HELOCs can be either a variable or fixed, HECMs can have substantially higher upfront fees than a HELOC, according to the Huffington Post.

Now, let’s discuss HELOCs.

HELOC

A HELOC also draws on your home, using the house itself as collateral. The lender will establish a maximum amount that can be drawn over a fixed term. The draw period is the period of time during which you can use the line of credit, which is followed by a repayment period during which you must pay any remaining balance on the credit line. For a HELOC, it’s typically 5 to 10 years. Unlike a HECM, HELOCs require the borrower to pay interest immediately and repay the entire balance before the repayment period expires.

Even though you have to pay interest immediately, a HELOC will probably be more cost-effective than a HECM if the borrower repays the balance shortly after drawing on the line of credit. This is because HELOCs tend to have lower interest rates and upfront fees.

Summary

Choosing between a HECM and HELOC primarily depends on how you plan to spend the money and how quickly you plan to pay it back. A HECM may be a better bet if you’re already at retirement age, especially if you plan to spend the rest of your life in your current house. If you’d like to learn more about Figure’s fixed-rate HELOC,^{1navigates to numbered disclosure} head on over to our information page.