If you’ve owned your residence for a while, you’ve probably built up a valuable amount of  home equity you can tap into and use as cash. Three popular ways to draw equity from your home include a reverse mortgage, a home equity loan or a home equity line of credit (HELOC).

All three of these financial instruments help homeowners access the equity in their homes, but they do so in different ways. Each allows homeowners to use the funds for any purpose, ranging from paying off their high-interest credit cards to remodeling a bathroom.

However, each financing option works differently and one of these options may be more suitable than the others. Before deciding between a HELOC vs reverse mortgage vs home equity loan, it’s worth comparing how each works and the advantages each one has.

Reverse mortgage

As the name implies, a reverse mortgage is the opposite of a regular mortgage: Instead of the individual borrowing money from a lender, then paying it back until they own the home, the lender pays the borrower — either in a lump sum, or monthly installments — in return for a stake in it.

The borrower is not required to make any repayments on the loan while they occupy the home. The loan does accrue interest, which the borrower can choose to pay off or have added to the loan balance. The loan comes due when the borrower chooses to move out, sells the home or dies (in which case the lender either is paid back in cash or takes possession of the home).

Homeowners have to be 62 or older to qualify for a reverse mortgage.

Takeaway: Reverse mortgages can work well if the homeowner needs to supplement their Social Security benefits, retirement account distributions or other fixed income for daily needs, emergency expenses or a single large expenditure.

Who it’s best for: An older homeowner who has paid off their mortgage or has a massive amount of home equity might consider seeking a reverse mortgage. The advantage of a reverse mortgage is that homeowners can tap their home equity in various forms — lump sum, regular monthly payments or line of credit — without having to repay it.

Home equity loan

A home equity loan is often called a “second mortgage” because many homeowners take one out in addition to their primary mortgage (though those who own their home in full can also take one out). A home equity loan uses your home as collateral. The terms are usually between five and 20 years, and the amount that can be borrowed is typically limited to up to 85 percent of the home’s combined loan-to-value ratio.

Homeowners receive a lump sum that they pay back in equal monthly payments at a fixed interest rate, which means they don’t have to worry about making larger monthly payments if interest rates rise. This can be helpful for people who are looking to budget a specific amount to repay each month.

Takeaway: A home equity loan or second mortgage gives you a fixed amount of money upfront, with set monthly payments for the length of the loan, but uses your home as collateral.

Who it’s best for: Borrowers with a lot of equity who have a specific purpose in mind for the money — and know exactly how much they’ll need upfront.

HELOC

A home equity line of credit (HELOC) gives a homeowner the ability to borrow money from the equity in their home and operates like a credit card. A person can tap their credit line if and when they need the funds During the first part of the HELOC (called the draw period), you can draw down money from the loan and make interest-only payments, which helps if you’re facing a tight budget. The draw period usually lasts five or 10 years.

Afterward, you enter the repayment period, which generally lasts 10 to 20 years. During this phase, your payments will include both interest and principal and they may be significantly higher than the payments you made during the draw period. The interest rate on a HELOC is generally variable, which can lead to higher payments during some months if interest rates spike, or lower monthly payments when rates go down.

Takeaway: A HELOC works similarly to a credit card, where you can spend as much or as little as you need at times of your choosing, up to a specified credit line amount.

Who it’s best for: If you’re not sure exactly how much money you will need, or will encounter expenses on a rolling basis, a HELOC can be a good option. You can withdraw at will, but you’ll pay interest only on the amount you’ve actually borrowed.

What to consider when choosing between a reverse mortgage, home equity loan or a HELOC

As with most financial instruments, each of these options has its pros and cons.

Tax advantages

If you want some tax savings with your financing, the advantage definitely lies with home equity loans and HELOCs.

“HELOCs and home equity loans can be tax-deductible for homeowners, but the rules around their tax deductibility have changed in recent years,” says Irvine, Calif.-based CPA Emily Egkan, a senior manager with the accounting firm Withum.

Once you could deduct an almost unlimited amount on loans used for any reason. But currently, single and joint filers who take out a home equity loan after Dec. 15, 2017, are allowed to deduct interest on up to $750,000 worth of qualified loans, and married, filing separately can deduct interest on up to $375,000 worth of loans.

Also, the loan has to be for a specific type of purpose. The tapped equity money must be used to “construct, or substantially improve an existing house” — the house or home that was used to secure the loan. Substantial improvements are those that add value to the home, prolong its useful life or adapt it to new use. Lastly, to be eligible, you’ll need to itemize your deductions when you file your taxes.

You might be able to take a deduction on reverse mortgage interest, in the same way you can on traditional mortgage interest. “However, it’s important to note that the amount of interest on a reverse mortgage that is tax-deductible may be limited,” Egkan says. Reverse mortgage borrowers can opt not to pay interest during the loan’s term, but just add it to the balance. If they do, the mortgage’s accrued interest (including the original issuance discount) is not tax-deductible until the loan is paid in full, according to Egkan. (You can’t deduct interest you didn’t pay.) 

The reverse mortgage is also likely to be subject to the same debt limits and home-use rules. So, no tax break for an elderly couple who took one out out just to make daily ends meet or help a grandchild with college tuition.

Credit score and income

You’ll likely need a credit score of 680 or higher to be eligible for a home equity loan or HELOC. But a credit score of between 620 and 679 may also be enough to qualify, depending on the lender.

“The credit score and income requirements will vary for reverse mortgages,” says Brad Baker, vice president of Underwriting and Capital Markets for Equity Now, a mortgage lending and servicing company in Mamaroneck, New York. “In general, HELOCs and home equity loans have more stringent credit and income requirements compared to reverse mortgages and home equity loans.”

Requirements

To qualify for each of these financing options, you’ll need to meet certain criteria.

To be eligible for a reverse mortgage — either a federally-backed  home equity conversion mortgage (HECM) or a private reverse mortgage — you usually must be a homeowner age 62 or older. (A small number of lenders offer reverse mortgage options to those as young as age 55.) Additionally, the home you are borrowing against must be your primary residence. You have to own the home outright or have a very low balance due on it when applying for a HECM reverse mortgage. Often, you are required to have accrued at least 50 percent equity. If you still have a mortgage balance, be prepared to pay it off when closing on the reverse mortgage. Also, you can’t be delinquent on any federal debt or use reverse mortgage funds to pay off federal debt. Your home must be in good shape, too, and you have to agree to receive counseling from a HUD-approved reverse mortgage counseling agency.

To qualify for a home equity loan or HELOC, you’ll need a debt-to-income (DTI) ratio of no more than 43 percent, a credit score of 680 or higher (possibly as low as 620), a history of punctual debt payments, a minimum of 15 percent to 20 percent equity earned in your home and a reliable and sufficient income source.

Disbursement

Wondering when you’ll get your money? The answer will vary depending on which of the three financing options you choose.

“Home equity loans disperse the full loan amount in a lump sum at closing. HELOCs allow the borrower to draw the funds as needed over time, as you would a credit card. Reverse mortgages usually disperse a fixed amount every month to the borrower, similar to an income stream,” says Baker.

Christina McCollum, regional manager for Churchill Mortgage, notes that your reverse mortgage lender may offer disbursement options. “You can take a one-time lump sum, a lump sum and deferred payments, or just deferred payments,” she says.

Repayment

The terms and timeline for paying back what you borrow will depend on the loan or line of credit.

“Home equity loans begin collecting payments immediately, just like a regular first mortgage, via a fixed amount every month,” Baker continues, noting that repayments cover both principal and interest. “HELOC payments will become due once money is actually drawn on the line, and the payment will be based on the total amount drawn thus far. During the HELOC repayment period, you can no longer access funds and you are required to make both interest and principal repayment over a 10- to 20-year period.”

According to Baker, a reverse mortgage does not require any payments monthly, “but your debt comes due at the end of the loan term. Reverse mortgage debt is typically repaid using proceeds from selling the home.”

Which option is best for you?

When choosing between a HELOC vs. reverse mortgage vs. home equity loan, your best option will depend on many factors.

“If you are a senior who needs to supplement your income to live comfortably, don’t intend to move, and don’t have heirs who want to receive the property free and clear, a reverse more may be your best choice,” says Lyle Solomon, a personal finance expert and attorney with Oak View Law Group in Rocklin, Calif. “In this situation, a reverse mortgage could relieve your financial burden and provide thousands of dollars to aid with living expenses, healthcare costs and other bills.”

On the other hand, if you need to pay for a high-cost home improvement/repair or want to consolidate and pay off high-interest debt, a home equity loan could be the ideal selection.

“A home equity loan provides an affordable solution for a home renovation project or to eliminate high-interest debt,” Solomon adds. “The lump sum payment you get from a home equity loan could also come in handy to make one large transaction, and home equity loans offer lower interest rates than credit cards and personal loans.”

Or, if you wish to use your equity to cover several bills over the next few years, a HELOC might be the perfect pick.

“For instance, a HELOC can help you use your home equity for each project in turn if you have three home improvement jobs you’d like to finish over five years,” says Solomon.

And remember, if the expense has anything to do with your home, using the home equity loan or credit line can also reap you some tax deductions.

What to watch out for

There are a few things that you’ll want to consider thoroughly before committing to one of these home equity financing options.

For starters, you’ll want to be careful about misusing the funds or racking up fresh credit card bills and falling deeper into debt.

Secondly, by taking out a loan against your home, you could be undoing years of equity-building. Additionally, taking on fresh debt could increase the risk that you won’t be able to pay it back. Failure to make timely payments could result in penalties, fees or foreclosure and your credit score could take a hit. This could affect your ability to borrow in the future or qualify for low interest rates.

If you have an adjustable rate, your payments could also increase as interest rates rise. Interest rates are unpredictable, and you could end up paying much more in interest than you originally intended.

The most common uses of HELOCs, and the ones recommended by personal finance pros, include paying for expensive home repairs and paying off high-interest credit card balances. If you’re using your home equity for any other purpose, you may find yourself on shaky financial ground.

Next steps

If you’re considering tapping into some of the equity in your home, you’ll first want to decide which of these products is right for you. But no matter which one you choose – a HELOC, reverse mortgage or home equity loan – you’ll need to gather your important documents like your home’s title, tax returns and proof of income. Having those documents handy will help expedite the loan process.

Comparing loan offers — at least three, preferably from different sorts of lenders — is always a good strategy. Lastly, if you are considering a reverse mortgage, consult with a nonprofit agency that does reverse mortgage counseling before entering into a loan agreement. The National Foundation for Credit Counseling (NFCC) offers access to NFCC-certified Home Equity Conversion Mortgage (HECM) counselors who can help seniors make the best choice for their circumstances.