Most homeowners who’ve had their property for a while have managed to generate some equity. While that often means that they’re getting closer to paying off any associated mortgage, home equity is also an asset they can tap into when the need arises. As a result, it can function similarly to a financial safety net in some situations. If you’re wondering what home equity is and how you can access it wisely, here’s a quick overview of the definition and a look at five smart ways to take equity out of your home.
What Is Home Equity?
In the simplest sense, home equity represents the difference between a house’s value and the amount of any remaining mortgages, loans, or other liens on the property. For most homeowners, calculating the equity is simple. You start by getting an estimate of your home’s current market value. Then, deduct the value of any remaining connected debts, such as mortgages. That final number represents their home equity.
It’s important to note that home equities can be positive and negative. If you owe less than the value of your home, you have positive home equity. As a result, you can potentially tap the equity for other purposes, giving you a source of cash for emergencies, projects, purchases, and more.
If you owe more than the current market value of the property, your home equity is negative instead. This situation is also referred to as being underwater. In this case, there’s no equity to tap, as the property is worth less than the connected debt.
5 Smart Ways to Take Equity Out of Your Home
1. Home Equity Loans
One of the simplest ways to tap the equity in your home is with a home equity loan. Also referred to as second mortgages, these lending products allow you to borrow against the existing equity without altering the terms of your current mortgage. Generally, they come with fixed terms, though the interest rate could be fixed or variable.
The process for getting a home equity loan isn’t unlike a traditional mortgage. There can be appraisals involved to ensure your home’s value aligns with the requested loan amount, as well as credit checks and income verifications. You’ll also encounter a range of fees, which can include origination fees, closing costs, and more.
After getting approved for a home equity loan and completing any required paperwork, you receive the amount you’re borrowing as a lump sum. Generally, you can use it as you choose. However, some home equity loans that involve paying off other debts may work differently. In those cases, a lender might send the required funds directly to your other creditors, so keep that in mind.
Like a primary mortgage, home equity loans do have your house serving as collateral. As a result, there is some risk involved. If you fail to repay the loan, the home equity lender could foreclose on the property, so keep that in mind.
2. Home Equity Line of Credit
A home equity line of credit (HELOC) also uses your home as collateral, allowing you to access a portion of your built-up equity. Additionally, the qualifications and origination process are similar to a home equity loan.
However, there is a key difference. Instead of receiving all of the equity you’re tapping as a lump sum, the account works similarly to a credit card. It’s a revolving debt, so as you pay back some of what’s borrowed, you can borrow that amount again if needed.
Usually, HELOCs have two phases. The draw period usually lasts between five and ten years. During that time, you can tap into the available funds. Interest does accrue, and you have to make payments to cover the interest. You can make payments toward the principal, though that isn’t required during that window.
The second phase is the repayment period. At that time, you have to pay back the interest and principal. As a result, the payments usually increase significantly. Additionally, you can no longer use any of the repaid funds as additional credit.
3. Cash-Out Refinance
With a cash-out refinance, you effectively refinance your existing mortgage, replacing it with a new one. During the process, you can borrow more than you owe on your current mortgage, and you’ll receive the difference between your old mortgage and your new one in cash, minus any applicable fees or similar expenses.
Like home equity loans, you can typically use the equity money for any purpose. However, if debt repayment is part of the plan, some lenders send those funds directly to the creditor to ensure those debts are paid off.
Since a cash-out refinance is generally like any other mortgage refinance, the process resembles what you encountered when you got your last mortgage. Credit checks, income verifications, appraisals, closing costs, and similar steps are usually part of the process.
You’ll also end up with a new repayment schedule and interest rate. As a result, cash-out refinances are potentially favored during periods where interest rates are lower than what you previously received, allowing you to potentially pay less in interest on the original amount borrowed. However, if you lengthen your repayment term or roll any fees into the new mortgage, any interest-related savings might be offset.
4. Shared Appreciation Mortgage
Shared appreciation mortgages allow you to tape your equity by selling a portion of your home to a company. In exchange, you receive cash from the business based on the current home value. Along with having to repay the borrowed amount and traditional interest – often at a rate far lower than many lender-based alternatives – you also commit to giving the company a percentage of any home value appreciation that occurs after the arrangement is made.
Overall, shared appreciation mortgages are complex, as a variety of contingencies and clauses can potentially be included. Additionally, you may need to take additional steps, including formal appraisals at the beginning and end of the associated term. The final payment that’s based on the appreciated value is also typically sizeable, which is risky if you aren’t sure you’ll be able to cover it when it comes due.
5. Reverse Mortgage
For homeowners who are at least 62 years old, a home equity conversion mortgage – also known as a reverse mortgage – is an option for tapping equity. These essentially are the opposite of a traditional mortgage. In exchange for committing your property to the reverse mortgage company, you’ll receive fixed monthly payments that you can use as a steady source of income for a specific period.
With this process, a debt is created against your house as payments are made. As a result, if you move or pass away, any proceeds from the home sale go to repaying the debt first. Typically, you also have the option of paying the debt voluntarily, allowing you to recapture your equity.
Reverse mortgages are often complex, and there are plenty of scams in this arena. Since that’s the case, it’s critical to find a reputable company and review the terms carefully to ensure you’re getting a sound deal.
Do you think that the options above are better options for how to take equity out of your home than some traditional alternatives? Have you ever used your home equity to achieve a goal? Have you tapped your home equity and later regretted that decision? Share your thoughts in the comments below.
Read More:
- How to Increase Your Home Equity for (Almost) Free
- How Equity Loan Calculator: How to Calculate Your Home Equity Loan Amount
- 4 Ways to Quickly Tap the Equity in Your Home
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