Options to Unlock Your Home Equity When Finances Are Tight

Can I get the equity out of my home without selling it?

You don’t have to sell your home to access your equity. If you meet eligibility requirements, many banks, credit unions, and other financial institutions have loans that allow homeowners to convert part of their equity to cash.

You can use that money for anything — debt consolidation, tuition, home renovation, or a dream vacation. However, those funds aren’t exactly mad money because you have to pay the amount back with interest. And, removing the equity from your portfolio of assets does come with certain risks. So, it’s in your best interest to leverage your equity’s power to improve your financial future.

While some lenders have customized loans for home renovation or other projects, the most common types of equity loans are cash-out refinance and second mortgages, which include a home equity loan or a home equity line of credit (HELOC).

Since all these loans use your equity in the home as collateral, they usually offer significantly lower interest rates and better terms than personal loans, credit cards, and other unsecured debt.

What qualifications do I have to meet to access my home’s equity?

Before you weigh your options, it’s best to determine if you qualify.

Banks, credit unions, and other lenders each have their own criteria.

However, according to James Nedved, vice president and mortgage production manager at Regions Bank in Orlando, Florida, homeowners are likely to qualify for home equity loans if they have:

• Owned the home for a year or long enough to build sufficient equity
• Made mortgage and other payments on time, and
• Maintained a credit score of at least 620.

How does a cash-out refinance work?

In a cash-out refinance transaction, you take out a new, larger mortgage and use the difference between your old loan and the new one as cash. You can take the equity out of your home, which is subject to current interest rates, and access funds for things like renovations, debt repayment, or emergency expenses.

The monthly payment on their new fixed-rate loan is based on the current interest rate and the new loan amount. Term lengths can vary.

Borrowers can finance closing costs into their new mortgage by increasing the loan amount, or by subtracting the expense from the proceeds of their cash-out refinance. No matter whether they spend the funds all at once or draw on them slowly over several years, their monthly payments encompass the entire $200,000 plus interest.

“You’re probably not seeing too many cash-out refinances right now,” says Lawson. “That’s because interest rates have gone up so significantly over the last six months.”

For example, it might not make sense for homeowners whose existing mortgage rate is 3.5% to refinance a large portion of the original loan plus additional funds at 6%. Other options might be more attractive.

What are the differences between a cash-out refinance and a secondary mortgage?

“A cash-out refinance is a mortgage transaction,” Nedved explains. “However, secondary mortgages — home equity loans and HELOCs — are consumer transactions, so they are governed by a different set of rules.”

Also, “because secondary mortgages are shorter-term loans than a cash-out mortgage,” Nedved says, “they are tied more to prime rate [similar to credit card rates, which are usually prime plus a percentage] than a mortgage is.”

Nedved says, “Many times, cash-out transactions are at a higher rate because you are taking equity out of your home.”

By contrast, second mortgages leave the first mortgage intact, which could save the homeowner money in the long run. Particularly if the homeowners bought the home in the last two years, “That pricing is a lot better than we can get today,” says Nedved.

Furthermore, Nedved says many banking institutions usually absorb the closing costs of home equity loans and HELOCs up to $250,000. Often, homeowners are only responsible for paying the cost of an appraisal.

However, secondary mortgages don’t work for everyone since every situation is different.

As a primary mortgage loan, the cash-out refinance tends to be repaid over a longer time period, so the amount of each monthly payment may be smaller than that of second mortgage options. With the ongoing inflation, a smaller monthly outlay may be easier on the family budget.

How does a home equity loan work?

Because interest rates continue to fluctuate unpredictably, homeowners with low-interest mortgages may find a home equity loan to be more cost-effective.

After finishing all their calculations, the homeowners above realize that a cash-out refinance is going to raise their monthly payments ridiculously.

As determined as ever to achieve their dream of paying off debt (or owning a vacation home), the homeowners investigate the possibility of a home equity loan.

To retain the 3% interest rate on their first mortgage, the couple applies for a second mortgage for the additional $100,000. If that application is approved, they now have two loans.

The balance on the first mortgage is $100,000 at 3% interest. The new loan is for another $100,000 at 6% interest (or whatever is the current rate), which is still more economical than the cash-out refi with $200,000 at 6% interest.

However, a second mortgage usually carries a higher interest rate than first mortgage rates nationwide. That’s because, in the case of foreclosure, the first mortgage lender will need to be paid in full from the proceeds of the home sale before the second mortgage lender can be paid.

Because it’s an installment loan, the couple receives all the funds upfront and pays back principal and interest on a pre-set schedule, usually over five to 15 years.

What are the advantages of a Home Equity Line of Credit (HELOC)?

Because they’re smart consumers who like to weigh all the options and value financial flexibility, our couple-homeowner example above decides to explore whether a HELOC is the best fit to utilize their equity and acquire additional funding.

Once they set up a $100,000 HELOC, the couple can withdraw some or all of the funds at one time or in various increments — in the same way they would use a credit card — over a five- to 10-year period. During that draw-down phase, they only pay interest on the amount they withdraw.

So, if they decide to pay off the medical expenses first to prevent going to collections, before they tackle the student debt or roof, their monthly balance reflects only the variable-rate interest on the amount paid to medical creditors. (It should be noted that while most HELOCs have variable interest rates, not all do.)

They do not repay principal and interest immediately. “And, you don’t pay anything on it, unless you draw from it,” Lawson explains.

However, when the draw-down period ends — even if they haven’t withdrawn the entire amount — they are ineligible to borrow any more money.

During the repayment phase, the borrowers typically have 10 to 20 years to repay any outstanding balance.

Because the interest-only payments made during the draw-down can be pretty modest, some homeowners suffer from sticker shock in the repayment phase. So, borrowers need to plan for those higher payments and the potential impact on the family budget.

Even if they don’t need cash right away, many homeowners proactively set up a HELOC as a rainy-day emergency fund.

“If you have a family emergency, want to renovate your home, need to make a large purchase or access a large amount of money quickly,” Lawson says, “having that vehicle set up gives you the availability of that capital.”

How do I know which home equity option is best for me?

“I have those conversations on a regular basis, and there isn’t a one-size-fits-all solution,” Nedved says. “We move towards the least costly option first, and if that doesn’t work, we aim for the best solution long term.”

For example, if the homeowners just want to add a pool, a HELOC might be the best option, Nedved shares.

If the homeowners’ first mortgage is at an amazingly low rate and they value the predictability of an installment plan, a traditional home equity loan might be the right choice, according to Nedved. If it’s a debt situation in which the family needs to have the lowest payment possible because the homeowner is on a fixed income, a full cash-out refinance might be more beneficial.

However, “The best option depends on a whole host of parameters that are specific to the client’s situation and what the total family budget looks like,” Nedved says. “That’s why it’s important to work with a trusted mortgage or consumer lending advisor.”

What are the pros of pursuing a home equity loan?

“Most people don’t have access to thousands of dollars in cash,” says Lawson. “So, the primary advantage of using your home equity is access to a large amount of capital in a short amount of time.”

Other advantages of taking equity out of your home can include:

• Lower interest rate than personal loans or credit cards
• Fewer fees than some loans
• More flexibility in repayment options
• Fewer borrowing restrictions

What are the cons of cashing out home equity?

While unlocking your home equity provides financial relief, seeking a second mortgage or cash-out refinance is not without risk. The less equity you have in your property, the higher your overall debt.

“So, if you were to lose your job, if a recession hits, if you come into harder financial times and you’re more highly leveraged on your property,” Lawson explains, “that’s a more risky situation to be in — with higher monthly payments and more uncertainty with your employment.”

For some homeowners, that scenario also brings back bad memories from the 2008 housing crisis. When home values plummeted, some homeowners realized they had maxed out their loan equity and had no financial reserves to draw on in an emergency.

“That doesn’t appear to be the case today,” says Nedved, who has been in the mortgage business for almost three decades, “But, that’s not an absolute. There’s always that risk.”

Other drawbacks of taking equity out of your home can include:

• Use of your home as collateral
• Potential for foreclosure and homelessness, if payments aren’t made
• Risk of declining home values

As a Realtor with over 15 years of experience, Lawson offers another perspective. “It’s kind of a pro and a con built into one,” he admits.

“People are concerned about the interest rates increasing so dramatically,” he begins. “But even rates at 5.5% and 6% are still historically low. So, even at those rates, home equity loans are still a great way to tap into a lot of capital.”

Who can I rely on to help make this decision?

Whether to access the equity in your home is not a decision to be made lightly. Fortunately, it doesn’t have to be made alone.

Both Lawson and Nedved advise collecting the appropriate documents, conducting your research, consulting with your family co-signers, and seeking out the expertise of some or all of these professionals, including a/an:

What should homeowners have with them before seeking the advice of a professional?

Before visiting the mortgage or consumer loan professional, it’s important to collect and present financial documentation, including:

• Last two years of W2s (or other appropriate evidence of income)
• Last three pay stubs
• Current mortgage statement

Some lenders may require a more extensive list of documentation, but these three are a good place to start. Nedved says The Big Three (above) and your credit score provide lenders with an accurate estimation of what you currently owe and how much additional debt you can afford.

Another essential element of a strong loan application is an honest conversation at home between adults applying for a loan together.

“If they can agree on where they are now and what their financial goals are, the mortgage lender can do a better job of navigating them towards their goal.”

No need to wait for dire economic straits

You don’t have to wait for a financial emergency to start looking into how your home equity could improve your financial future.

By using HomeLight’s Home Value Estimator, you can quickly and easily approximate the value of your home and then deduct what you owe to determine your ballpark equity.

Using your equity to pay off high-interest debt, tackle home renovations, or even buy another property can be a smart move. A HELOC might offer peace of mind by giving you flexible access to funds while keeping your current mortgage intact.

For others, a home equity loan may provide a more cost-efficient path, or the longer repayment term of a cash-out refinance might better suit the family budget. In the end, you might also decide that the best choice is to leave your equity untouched, for now.

Editor’s note: This blog post is for educational purposes only, not legal or tax advice. Reach out to your own advisor for professional guidance on unlocking your home’s equity.

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