If a home is worth $300,000, for example, and you only owe $100,000 on it, many lenders would consider giving you tens of thousands of dollars in new loans, borrowed with your home as collateral. You don’t have to sell your home to access your home’s equity, although that is one way to extract and use your equity. Instead, you can use various loan products to finance new purchases. While not every expense is a good reason to tap your home equity, if you need to meet a big expense or need ongoing cash flow, your home equity is one of the tools you have available. We’ll look at how each of these products and strategies is structured so you can make an informed choice.
Reasons To Tap Your Home Equity Without a Reverse Mortgage
A reverse mortgage is a method of giving retirees and those nearing retirement access to their wealth when it is tied up in a home in which they intend to continue living. While this product can generate income or fund home improvement projects, it can, at times, result in having to sell the home immediately when the homeowner moves out or dies because the reverse mortgage comes due. Other types of loans are structured to have payments along the way or do not require the funds to be paid back, in comparison with the way a reverse mortgage comes due all at once. “Reverse mortgages are a niche product for seniors and [are] more of a lifestyle choice. There are a few companies that are experts in helping those borrowers understand and make their decision,” Scott Smith, assistant vice president of Enterprise Programs at credit union SECU Maryland, told The Balance by email.
Options for Taking Equity Out of Your Home
Lenders have created many ways to access your home equity and use it for other purposes, all with different structures. With each, it varies as to whether you pay costs upfront, interest along the way, and how you pay back the loan.
Cash-Out Refinance
A cash-out refinance is a way to refinance your mortgage that also pays you part of your home’s assessed value based on your amassed equity. If you had bought a home at $200,000 and now it’s assessed as being worth $300,000—and you still have $100,000 due on the original mortgage—you might refinance, get a lower interest rate or a different term, and also “take out” $20,000. This would make your new total mortgage balance $120,000. The thing to remember with a cash-out refinance is that it isn’t really cash any more than other forms of lending; it’s like you bundled a personal loan into your mortgage loan. While this can be a great way to finance home improvements or other home-value-enhancing changes with a low-interest loan, spending it on everyday expenses puts you further away from paying off your house.
Home Equity Loan
A home equity loan doesn’t replace your mortgage loan in the way that a cash-out refinance does. Instead, it’s a separate loan secured by your home’s value. If you were to default on the loan, both your mortgage lender and your home equity loan lender would have access to any funds generated by a foreclosure sale of the home. This kind of loan can be offered at an affordable rate because of this drastic option for lenders to recoup losses, which can minimize risk. Home equity loans tend to work well if you know ahead of time just how much you need, because they typically are delivered as a lump sum, then paid back in equal monthly payments over a set time frame.
Home Equity Line of Credit
A home equity line of credit, or HELOC, is also a way of borrowing that is secured by your home’s equity. Instead of requiring a lump sum with a fixed rate and a payment schedule, you borrow up to your limit when you need it, then pay it back during the designated payback period using minimum payments or more, much like a credit card. However, the interest rates you can get for a HELOC usually are much better than unsecured credit cards. A HELOC can carry additional fees if you keep it open but don’t use it for a long time, for instance, but if the fees involved are reasonable, it can be a nice option to have for financing unpredictable expenses, such as a big home repair or quickly committing to a home improvement project when you see materials on sale.
Home Equity Sharing Agreement
Another structure that has become available to allow homeowners to cash out some of their equity is the option to sell a minority share in their home to an investment company. Instead of receiving interest, the company is legally granted a portion of your home’s appreciation at the end of the agreement. While each kind of equity sharing is structured differently, the best way to judge whether one is good for you is based on how much the investment company will take if your home appreciates, depreciates, or holds value. If your home is poised to increase significantly in value, this agreement could benefit the company more than you. Also, you would pay less overall by instead getting a loan or line of credit.
Downsizing
The most clear-cut way to get equity out of your home is to actually sell it and purchase a less-expensive home elsewhere or choose to rent. Both these steps should liberate some of the money previously tied up in your home equity.
What’s the Best Way To Tap Your Home Equity?
With each product or agreement, you’ll need to assess the associated expenses, including closing costs, interest, and any potential payment fluctuation, which might result from an adjustable rate on a HELOC. You’ll also need to determine how much money you really need, and when. Cash-out refinances make the most sense when interest rates for mortgage loans have fallen since you first took out your mortgage. Home equity sharing agreements require you to bet that the portion of your home’s appreciation that you hand over isn’t too high when compared with the costs of other loan products, as it’s not easy to forecast the home’s appreciation in the years of the sharing agreement. The best way to make your final choice is to work through the risks posed by each product you’re considering versus the benefits conferred. “The primary risk—as with any loan—is overextending and ending up with payments that are unaffordable,” Smith said. He counsels that payments with adjustable rates could become unaffordable if your current bills are already stretching your budget, so think through several potential scenarios before committing to a method to get equity out of your home. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning! income, and a solid amount of equity in your home may make tapping into your home equity easier. You’ll need to talk to lenders to determine whether your credit score disqualifies you, but in the meantime, paying credit card bills on time and making other efforts to improve your credit are wise moves.
