For Canadian homeowners seeking access to more cash flow without moving or selling their home, tapping into home equity can be a smart financial move.
Two popular financial options among older homeowners are the home equity line of credit (HELOC) and the reverse mortgage.
Let’s dig deeper into the pros and cons of these two financial tools, and when each may be appropriate for you.
What is a HELOC?
A HELOC is a type of revolving credit secured by your home. Revolving credit allows you to borrow money up to a maximum credit limit. As long as you have credit available under your HELOC, you can borrow against it, pay it back, and borrow again—when and if needed. You only pay interest on the withdrawn amount, until you pay it back in full.
How does it work in Canada?
In Canada, a HELOC can give you access to as much as 65% of your home value. The credit limit is determined by a percentage of your home's appraised value, minus any outstanding mortgage.
What is a reverse mortgage?
Designed specifically as a tool for those looking to ease cash flow in retirement, a reverse mortgage allows you to turn a portion of your home equity into a source of tax-free cash, providing access to funds that require no monthly payments.
You can borrow up to 59% of your home’s value and receive your tax-free funds as a lump sum or as payments over time, all while retaining ownership of your home. You are only required to meet your mortgage obligations, which include paying your property taxes and home insurance, and keeping your home in good repair.
While reverse mortgage interest is added to the outstanding loan balance, the value of your home may continue to appreciate each year. Repayment of a reverse mortgage is generally only required once you pass away or decide to sell your home. When you do sell, the proceeds are used to pay off the outstanding loan amount, and you or your heirs get to keep the rest.
Learn more about how a reverse mortgage works.
Comparison: Reverse mortgage vs. HELOC
While both a HELOC and reverse mortgage allow you to access home equity, they have some significant differences.
| Reverse mortgage | HELOC |
|---|
| Repayment
| No monthly payments required. Repayment of the loan is only required when the homeowner decides to sell, move, defaults, or the last borrower passes way. Interest accrues onto the loan balance each month, unless you choose to make monthly interest payments. | Monthly interest payments are required. Payment amounts can fluctuate, as HELOC rates are typically variable (unless you fix a portion of the drawn amount). Interest accumulates only when money is withdrawn. |
|---|
| Eligibility
| Based on: - Age
- Property type
- Home value
- Location
| Based on: Lenders require stricter income and credit score requirements to ensure your ability to make repayments. |
|---|
| Interest rates
| Typically higher than HELOC rates You can choose between fixed or variable rates, with interest accruing over time. | - Typically variable (with ability to fix a portion)
- Typically lower than reverse mortgage rates
- Tied to the prime rate
Can be harder to qualify for as a retiree on a low or fixed income. |
|---|
| Credit limit
| Depends on your location, age, and home’s value. | Depends on your credit score, how much home equity you have, and your ability to service the interest of the loan. |
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| Purpose of funds
| No specific limits on what funds can be used for. Typically used to:
- Pay off your existing mortgage or other debt
- Renovate your home
- Gift a downpayment to a loved one
- Manage the rising cost of living
- Cover healthcare costs
Funds can be accessed all at once as a lump sum, as scheduled payments, or as a combination of both. | No specific limits on what funds can be used for. Typically used to:
- Pay down high interest credit card debt
- Renovate a home
Funds are accessed on an as-needed basis, similar to a credit card. |
|---|
Pros and cons of a HELOC
Pros
- Borrow up to 65% of your home’s value
- Lower interest rates
- Money can be used whenever you need
- Interest is paid only when money is withdraw
- Credit is revolving and prepayments are permitted at any time
- Can be fully prepaid without penalty
Cons
- Credit score and proof of income requirements aren’t ideal for retirees
- Monthly interest payments are required
- Rates can fluctuate, which affects your monthly payment amounts
- Lenders may require requalification when life changes (i.e., when a spouse dies)
Pros and cons of a reverse mortgage
Pros
- Borrow up to 59% of your home’s value
- Stay in the home you love
- Monthly payments are not required, until you move, sell, or the last borrower dies or defaults
- Qualifications are based on age, home value, and location, not income or credit score
- Ability to make prepayments, if you choose, to lower the cost of interest over time
- The “no negative equity guarantee” ensures you’ll never owe more than the market value of your home, as long as you meet your mortgage obligations
- Spousal protection ensures that in the event of a borrower’s passing, the remaining homeowner will not have to requalify for the mortgage or be forced to move out of the home
Cons
- Interest rates are typically higher, as monthly payments aren’t required
- A reverse mortgage may limit other financing options secured by your home (i.e., you may not be able to take out a HELOC or similar products at the same time)
- The equity in your home may decrease as you accumulate interest, if you choose to not make interest payments
- Fees involved, such as closing fees, Independent Legal Advice, and a home appraisal
To learn more, check out our blog post about reverse mortgage pros and cons.
By understanding the nuances of the mortgage and HELOC, as well as your own financial needs, you’ll be well on your way to making an informed decision around tapping into your home equity.
Whether opting for the flexibility of a HELOC or the unique benefits of a reverse mortgage, Canadians have powerful tools at their disposal for unlocking the financial potential in their homes. As the reverse mortgage is designed specifically for those in or planning for retirement, it can be beneficial to older homeowners looking to make the most of their retirement years.