The equity you have in your home is not liquid, meaning it cannot be converted to cash quickly and easily, however many financial institutions will utilize these four ways to lend you money, leveraging those funds against your home’s built up equity.
1. Home Equity Loan
Often referred to as a second mortgage, with this type of loan you are borrowing against the equity you’ve built up in your home. Funds are distributed in one lump sum and payments towards this second loan must be made monthly, just like your first mortgage, until you’ve paid back the money you have borrowed.
Interest rates for home equity loans are typically very low, therefore people typically choose this type of loan for large purchases such as wide scale home remodel projects, medical bills, or to further their child’s or their own education. This type of loan does have its limitations and typically lenders will require you to maintain at least a 15-20% ownership of your home.
2. Home Equity Line of Credit (HELOC)
A HELOC is similar to the home equity loan, however in a HELOC there are two distinct periods, the draw period and the repayment period. HELOC’s are very flexible, allowing the homeowner to draw from the loan whenever they see fit, much like a credit card. Owner’s can also use the funds to consolidate or pay down or off other higher interest debt such as auto loans, high interest credit cards, college debt, or pay the expenses of materials and labor needed for a home remodel. After a specified amount of time the homeowner will enter the repayment phase and no longer be able to draw funds from their home equity.
Added bonuses to HELOCs-
You only need to make payments on the amount that has been drawn
Typically this bears no closing costs
Interest paid on your HELOC is tax deductible on your federal tax return
3. Cash-Out Refinance
This involves refinancing your home in order to provide the homeowner with additional funds (cash). In this case you refinance your home for a larger amount than you owe on your current home loan while taking the difference in cash. Your new loan could have longer repayment terms and/or a higher or lower interest rate than the previous loan that you are dissolving. Interest rates are typically fixed for cash-out refinancing and lower than those offered for home equity loans. Closing costs however can be high.
4. Reverse Mortgage
Some choose to use their home equity to help fund their retirement. If you are a homeowner that is 62 years of age or older you may qualify for a reverse mortgage under HUD, a federal program that stands for Housing and Urban Development. If eligible, owners can access a portion of their home equity by borrowing against it. With a reverse mortgage you’ll stop making monthly mortgage payments and instead will receive funds based on the amount of equity you have in your home, your age, and current interest rates. You can elect to receive payments in one lump sum, regular monthly payments, or a line of credit.
You are obligated to pay back the loan once you no longer reside in the leveraged home for more than 6 months of the year or once you pass away. The profits from the sale of your home would then pay your reverse mortgage loan. Any remaining funds would be given to your heirs. These loans are non-recourse loans, meaning your heirs won’t be forced to pay anything more towards the loan than what they can get from the sale of the home.
Smart Decision Making Tips
As with any large financial decision it is wise to speak with a financial advisor before converting your home’s equity into cash. Consider the following questions before making your final decision:
Can I afford two loans?
Can I lower my interest rate?
What ways of borrowing money against my home’s equity do I qualify for?
How many years will it take to repay?
What can I expect to pay in interest?
Am I going to get taxed on proceeds?
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