Summary
- There are at least 5 popular ways to access your home equity.
- The main way to know which home equity product is for you is to determine what you need the money for, how much money you need, and how long it will take you to pay it back, if ever.
- There are other very important considerations like credit score and credit history, home equity percentage, and how long you plan to stay in the home.
If you’re a homeowner looking to access your home equity for cash, you’ve got a few options to choose from. You can pick a HELOC, home equity loan, cash-out refinance, reverse mortgage, or home equity investment. Each one has its own perks and features, and the best one will depend on your own circumstances, goals, and preferences.
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Access Your Home Equity Overview
Home equity loans are a popular choice for many folks considering home improvements, those who want to consolidate debt, or those who know exactly how much cash is needed. Home equity line of credit (HELOC) are similar to home equity loans but offer the flexibility of continuously drawing funds, so it can be a good choice if you’re not sure how much cash you need, or want to be able to regularly access more cash in the future.
A cash-out refinance can be a good option if you want to completely replace your existing mortgage with a new interest rate, loan amount, or loan term. It’s also worth considering if you don’t want to deal with multiple mortgage payments on your home.
There are also ways to tap into your equity without being obligated to make monthly payments on a loan. With a reverse mortgage, you can have a lender pay you in exchange for the equity in your home. A home equity investment allows you to get cash today, as long as you agree to give up a portion of your home’s future increase in value.
Read one as we’ll go through each of these programs in more detail to help you decide which one you should choose.
1. Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) allows you to borrow against the equity in your home, up to a credit limit specified by the lender. In many ways, it’s like the credit limit on a credit card, except a HELOC is secured by your home. Make sure you can afford the monthly payments though because missing enough payments could result in the lender foreclosing on the home and kicking you out.
A HELOC has two phases: the draw (borrowing) period and the repayment period. You’ll make payments on the loan during both periods, but can only access home equity during the draw period. For most HELOCs, the interest rate you pay will change with fluctuations in the market, so the monthly payments could go up or down each month.
- Pros: Flexibility to access the cash you need (and pay interest) only when you need it. When interest rates are higher, you don’t lose your lower rate on your first mortgage.
- Cons: Your monthly payment will fluctuate over time based on changes in interest rates and the amount of equity you access. This involves taking on a second monthly mortgage payment.
2. Home Equity Loan (HEL)
Also known as a home equity installment loan or second mortgage, home equity loans allow you to borrow equity in your home and receive a lump sum payment. The interest rate is fixed and it’s called a second mortgage because it doesn’t replace your existing mortgage — which is especially nice if interest rates have gone up and you don’t want to lose the low rate you already have. You make fixed monthly payments covering principal and interest on the new mortgage amount, plus you continue to pay your existing mortgage payments.
Although a home equity loan and a HELOCs are similar, there are at least a few important differences. The first major difference is the interest rate — the interest rate on a home equity loan is fixed, whereas it is a variable rate loan for HELOCs. Another major difference is that a home equity loan is a closed-end loan, meaning once you obtain the proceeds from the home equity loan, you do not have the ability to access more equity without applying for a brand new loan altogether. The third major difference is that a home equity is a one-time lump sum payment, whereas HELOCs have a drawdown period similar to credit cards.
Home Equity loan vs HELOCs
• Loan Type: close-end loan for home equity loan, open-ended drawdown for HELOCs
• Interest Rate: fixed rate loan for home equity loan, variable rate loan for HELOCs
• Payment Type: one-time lump sum payment for home equity loan, line of credit for HELOCs
Besides those major differences, home equity loans are very similar to HELOCs. Both use your home as collateral for the loan, so missing enough payments could result in foreclosure. You’ll also need to meet the lender’s requirements for things like credit score, income, and property value.
- Pro: When interest rates are higher, you don’t lose your lower rate on your first mortgage.
- Con: You’re taking on a second monthly mortgage payment.
3. Cash-out Refinance
In a cash-out refinance, you take out a brand new mortgage that completely replaces your previous mortgage (your previous mortgage goes away). You make fixed monthly payments covering principal and interest on the new mortgage only. Mortgage Refinancing is in contrast to HELOCs and home equity loans because the latter are additional mortgages on your property.
With a cash-out refinance, the amount of the new loan is used to pay the existing mortgage on your home, while the excess can be deposited into a bank account to be used for a variety of purposes, including home improvements and debt consolidation.
Example
Let’s consider a scenario where your existing first mortgage has a balance of $200,000 and you obtain a new loan amount of $300,000. Since the new loan amount of $300,000 is more than enough to pay off the existing first mortgage of $200,000, the extra $100,000 is considered the cash-out portion of your loan that can be deposited into one of your bank accounts.
Depending on the lender, you may have the option of either a fixed or adjustable-rate mortgage. Regardless, interest rates are typically more competitive on cash-out refinance when compared to home equity loans and HELOCs. The tradeoff though, is that closing costs tend to be higher. Using a mortgage calculator to determine the total cost of the loan can help you decide whether a cash-out refinance is the more affordable option.
- Pro: When interest rates are lower, you benefit on the entire amount of your loan.
- Cons: When interest rates are higher, you’ll lose your lower interest rate through the re-fi. Your monthly mortgage payment will likely increase.
4. Home Equity Investment
A relatively new product, equity sharing agreements let you “sell” a share of your home’s future appreciation via a service that matches homeowners with investors. You live in your home as normal, receive cash up-front, and don’t make any new monthly payments. At the end of the agreement term, the investors share in the upside if your home goes up in value — either by you repaying the loan from other assets or selling your home.
In other words, in exchange for a lump sum of cash today, you agree to give the equity investment company a share of your home’s increase in value after several years (often 10-15 years). We can use a quick example to illustrate how this might work:
Example
Let’s say you own a $500,000 home free and clear. In exchange for $100,000 in cash today, you agree to give the equity investment company 20% of your home’s equity increase after 10 years. Let’s say your home is worth $700,000 after 10 years. At that point in time, you would owe the company 20% of the $200,000 increase in value (along with any fees and extra charges), on top of the original $100,000 in cash that you received.
- Pros: No monthly repayment. You don’t need a high credit score. If your home goes down in value, you owe much less.
- Cons: High transaction fees. If your home value does increase, you’ll likely be paying a much higher effective interest rate on the cash you received compared to other options.
5. Reverse Mortgage
Available for homeowners 55 years and older (for private reverse mortgages) or 62 years and older (for non-HECM reverse mortgages), a reverse mortgage is a home loan that allows you to eliminate your current mortgage payment (if any), withdraw some of your home equity as cash, and continue to live in your home. You don’t have to pay taxes on the proceeds or make any monthly payments. You can receive the money as a lump sum, a fixed monthly payment, a line of credit you can use when needed, or some combination of those. You still pay your property taxes, homeowners insurance and for general home upkeep. The loan is repaid only when you are no longer living in your home, either from other assets you have or from the sale of the home.
Banks often only offer a reverse mortgage on a home that is owned free and clear or one that has a significant amount of equity. Homeowners must continue to live in the property, but are not required to make any monthly payments to the lender, and will instead receive cash payments based on the specific terms of the reverse mortgage. The loan typically does not have to be repaid until the home is sold, the owner decides to move out, or passes away.
- Pros: Eliminate your current mortgage payment — and no new monthly payments. Option to receive monthly, tax-free income.
- Cons: Age requirement. Best for those who plan to stay in their home long term.
Click here to see if you qualify for a reverse mortgage!
When is it better to get a HELOC, home equity loan, cash-out refinance, home equity investment, or reverse mortgage?
- HELOC: A HELOC is a line of credit and a great choice if you’re uncertain how much cash you’ll need, or want the flexibility of having access to cash in the future at any time. These loans are commonly used for debt consolidation and paying for home improvements.
- Home equity loan (second mortgage): Home equity loans are similar to HELOCs, but because they offer a fixed interest rate for a one-time lump sum payment, they’re a great choice if you need the cash now and know exactly how much cash you might need for things like debt consolidation. Also, if you want peace of mind knowing that your monthly payments will not change, these loans are also a good choice.
- Cash-out refinance: When interest rates are low, or if you want to replace your existing mortgage with a new loan, a cash-out refinance is likely your best option. With a cash-out refinance, you can choose a new mortgage loan with a new interest rate, loan term, and loan amount.
- Home equity investment (home equity agreement): If you want to get access to cash without having to make monthly payments on a loan (or are unable to qualify for a loan that does require monthly payments), a home equity investment is a good option to consider. The amount of equity you currently have in the home will determine how much cash you can receive, and you’ll typically have at least 10 to 15 years before you need to pay it back to the lender. When you do end up repaying the lender, you’ll have to pay back the lump sum of cash, in addition to a percentage of your home’s increase in value.
- Reverse mortgage: Since you have to be at least age 55 or older to get a reverse mortgage, this is a great option to consider if you’re looking to supplement your monthly retirement income, without having to make monthly payments. Since you’re drawing on your equity in exchange for monthly cash payments from a lender though, this can be a particularly good option if you’re not concerned about passing on the home to other family members.
Comparison of loan programs
| HELOC | Home equity loan | Home equity investment | Reverse mortgage | Cash-out refinance | |
|---|---|---|---|---|---|
| Monthly payments | yes | yes | no | no | yes |
| Fixed vs. Variable rate | Variable | Fixed | – | – | Both |
| Ability to continuously draw funds? | yes | no | – | – | no |
| Eligibility requirements | Worthy credit, stable income, equity requirements dictated by the lender and enough equity to cover fees. | Worthy credit, stable income, equity requirements dictated by the lender and enough equity to cover fees. | Varies by lender, but generally must have 20-30% equity in the home | Age 62 or 55, own home free and clear (or have significant equity) | Worthy credit, stable income, equity requirements dictated by the lender and enough equity to cover fees. |
| Minimum Credit Score | 620 | 620 | 500 | None required | 620 |
| Repayment period | Generally, 10-30 years | Generally, 10-15 years | Generally, 10-15 years | Upon sale of the home, moving, or owner passing away | Generally, 7 to 30 years |
| Useful for: | Home improvements, debt consolidation, bills (medical, credit card, school, etc) | Home improvements, debt consolidation, bills (medical, credit card, school, etc) | Home improvements, debt consolidation, medical bills; individuals looking to avoid monthly payment requirements | Supplementing retirement income; circumstances where the house will not be passed to a family member | When market interest rates are lower than your current mortgage interest rate. |
Track and access your home equity
HELOCs, home equity loans, cash-out refinances, reverse mortgages, and home equity investments are several popular ways to tap into your home equity for cash. Each program has its own set of pros and cons though, so you’ll want to think about your own personal circumstances to determine which one is best for you. Also, consider what you can comfortably afford, and make sure you understand the terms of the loan as some of these can be rather complex.
