“I have a lot of home equity now, but so what? I’m not sure how to access it, or if I even should?” Is this something you’ve thought? I hear some version of this all the time from homeowners.
The run-up in home prices since 2012 has left U.S. homeowners with a record amount of home wealth. Current homeowners with mortgages are sitting on an average of $207,000 in equity that they could access while still keeping a 20% equity buffer.
What can you do with home equity? Almost anything. It may make sense to use your home equity to help pay off higher interest debt, renovate your home, cover an unexpected expense, or pay for retirement. Here are the five main ways to access your equity:
1. Home equity loan
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 usually fixed. It’s 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.
- 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.
2. Home equity line of credit (HELOC)
A HELOC is a type of second mortgage that allows you to borrow money against your equity as a line of credit — meaning, the lender will tell you the maximum amount available and you can access cash up to that limit over time, when you need it. 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.
- 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 changes over time, depending on interest rates and how much equity to you access. You’re taking on a second monthly mortgage payment.
3. Cash out refinance
In a cash-out refinance, you take out a new mortgage for more than your previous mortgage balance. The difference is paid to you up-front in cash, and this new, larger mortgage replaces your previous one. You usually pay a higher interest rate on a cash-out refinance compared to a regular rate/term refinance. You make fixed monthly payments covering principal and interest on the new mortgage amount.
- 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. Reverse mortgage
Available for homeowners 55 years and older, 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.
- 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!
5. Equity sharing agreement
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.
- 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.
Conclusion — get educated, unbiased advice
These products are often complicated, and it’s hard to figure out which one is right for you. Each of these five categories may have dozens of lenders offering different financial terms, structures, risks, and benefits. What’s right for you depends on your unique financial profile and goals.
At House Numbers, we specialize in helping you consider these options.