According to the latest estimates from the Federal Reserve, homeowners in the U.S. control nearly $15 trillion in home equity as of the first quarter of 2018, up by roughly $1.5 trillion from the same period in 2017. Increases in home prices, tight inventories of houses for sale and paid down principal on existing mortgages all contribute to this increase. But the question for most homeowners is, “How can I tap my equity without selling?”
Home equity loan
Do you want to tap your home equity for a one-time event and prefer the security of a fixed rate loan? Then a home equity loan (HEL) may be the right option for you.
A home equity loan is essentially a second mortgage where you receive the money as a lump sum. Interest rates on HELs are typically fixed, and you repay the loan via a set amount paid monthly.
Home equity line of credit
Would you prefer access to cash over a period of time that you can use as needed? Then a home equity loan (HELOC) is what you’re looking for.
A HELOC is a revolving loan that works like a credit card – you can draw cash as you need it up to a predetermined credit limit and pay interest only on the amount outstanding at any given time. Your equity can be borrowed and repaid as often as needed over the HELOC’s term.
HELOCs are typically adjustable rates loans so your monthly payment may go up or down as interest rates shift. Because of that uncertainty, in most cases, interest rates are initially lower for a HELOC than a HEL.
Cash out refinance
Do you want to refinance your home to take advantage of lower rates? Is it time to switch from an adjustable rate mortgage to a fixed-rate loan? You can get extra cash in the process with a cash-out refinance.
With a cash-out refinance, you refinance your entire mortgage into a new loan. Your new mortgage is for a larger monthly payment, and you get the difference between the two loans in cash. Interest rates on a cash-out refinance mortgage may be fixed or adjustable.
If you are thinking about refinancing, you should make sure you have your financial house in order.
Shared appreciation agreement
HELs, HELOCs and cash-out refinancing are typically only available to borrowers with strong credit. Another option exists for borrowers who have a lot of equity in their home and also have had some trouble with credit in the past.
A shared appreciation agreement allows you to cash out some of the equity in your home in exchange for giving an investor a minor ownership stake in the property. Don’t worry, that ownership stake does not permit the investor to live in the property or lease it out! It just gives them a financial interest in any increase or decrease in the value of the home.
Like a HELOC, HEL or mortgage, a shared appreciation agreement is secured by your home, but it does not require a monthly payment. At the end of the term, you owe the amount borrowed and also a percentage of the appreciation in your home’s value.
How much can I borrow?
Whichever tool you choose, the amount you can borrow is limited by the equity you have in your home and the lender’s loan-to-value (LTV) requirements.
LTV compares the balance of your mortgage to the appraised value of the property. For example, if your home is worth $300,000 and your current mortgage balance is $100,000, your LTV is 33%. If you were to borrow an additional $50,000, your combined loan-to-value would be 50%. Most home equity lenders require a combined LTV of 85% or less.
Tapping your home’s equity can be a good idea if you can take advantage of low interest rates. Use the proceeds wisely and you won’t have trouble paying back the amount borrowed. But before you pursue any of these solutions, consider the costs and the impact. It will influence your monthly debt payments, remaining home equity and mortgage term. Using your home’s equity as collateral for a loan can help you access a valuable asset, but you also run the risk of losing your home if you run into financial trouble.