The Short Answer
For homeowners who have built up equity in their home, tapping into this can be a successful way to find extra funding for various purposes. There are a few options for homeowners to do this:
- Home equity loan
- Cash out refinance
- Reverse mortgage
Calculating home equity involves finding out the market value of the home, then subtracting the outstanding mortgage balance from this. Lenders have different rules about the percentage of the home’s value they will allow a borrower to use, so this Loan-To-Value (LTV) ratio needs to be factored in, as well closing costs and other fees.
How To Pull Equity Out Of Your Home
Home equity refers to the amount of the home that you outright own, which is essentially the difference between the appraised value of the home and the amount still owed on the mortgage. Equity in a home can be an extremely valuable asset and there are various ways of tapping into it, depending on the purpose.
Method 1: Home Equity Loan
Home equity loans allow people to access the equity in their homes by borrowing a lump sum of money. A home equity loan is a second mortgage, which will have a its own terms and rates, over a fixed period of time. This means that two mortgage payments will need to be made each month.
The main benefits of a home equity loan are that it is cheaper than a personal loan and comes with a fixed rate so borrowers can budget around a fixed amount. These loans also have lower interest rates than credit cards, which means that they are more affordable over the long term.
Method 2: Home Equity Line of Credit
A home equity line of credit (HELOC) is different to a home equity loan in that it is a revolving line of credit that can be used as and when the borrower needs access to the funds. It’s similar to a credit card, where a certain amount can be borrowed, with a limit. A HELOC is also a second mortgage and has a separate set of rates and terms to the original loan.
HELOCs are divided into two payment periods. The first is the draw period which can last several years (often 5-10), depending on the lender. During this period, the borrower can use money from the loan, as they need it, and can enjoy interest only payments. After this period comes the repayment phase, where the borrower will need to begin paying back the principal amount and can no longer borrow money or make interest only payments.
One of the most useful benefits of HELOC loans is that they are flexible. They can be used for home improvements, debt consolidation, education expenses, or unexpected emergencies.
Method 3: Cash out Refinance
A cash out refinance involves replacing an existing mortgage with a new one that is a larger amount. This way, the difference between the old mortgage and new loan can be given to the borrower in cash. This cash be used however a borrower needs to use it. The cash out refinance will have new loan terms and rates, which are often lower than the original mortgage.
The main benefits of a cash out refinance is the fact that the money is paid out to the borrower in cash, the new loan will replace the old one which means that there is still only one monthly payment, and the terms of the new loan can be more favorable.
Method 4: Reverse Mortgage
A reverse mortgage is for senior citizens, aged 62 and older. It allows them to convert a portion of that equity into tax-free cash without selling their property. Unlike traditional mortgages, in a reverse mortgage, the lender makes mortgage payments to the homeowner, and the loan is repaid when the homeowner leaves the home or passes away.
The benefits of a reverse mortgage are that there are no monthly payment requirements, and no interest payments required while the owner is still living in the home. Another significant benefit is that the homeowner or their heirs will not owe more than the home’s value at the time of repayment, even if the loan balance exceeds the home’s value.
How Much Equity Can You Cash Out?
To work out how much equity you can access in your home, you’ll need to calculate the current market value of your property and then subtract any outstanding mortgage balance or other liens against the property. The resulting amount represents the equity you have in your home, which may be available for you to access. Here’s a step-by-step guide to determine how much equity you can cash out:
Step 1: Determine the current market value
To find out the current market value of your home, you can start by researching home values in your local real estate market. This means using online platforms like Zillow or Redfin to find the value of similar properties in the area. You can also hire a property appraiser to get the exact value of your property.
Step 2: Find out your mortgage balance
By contacting your lender, you can find out what you still owe on your current mortgage. This includes the principal amount and any interest. This is a key step to determine how much equity you can access from your mortgage by looking at the base mortgage numbers and how much you have paid off.
Step 3: Calculate your home equity
Next, you will need to calculate the equity that you have generated in your home. You can do this by using the values obtained above, and plugging them into this formula:
Home Equity = Current Market Value – Outstanding Mortgage Balance
For example, if your home’s current market value is $350,000 and you still owe $170,000 on your mortgage, your available home equity would be:
Home equity = $350,000 – $170,000
Step 4: Consider lender limitations
Some lenders have a maximum LTV ratio, which means that borrowers can only access a certain amount of their home equity. For example, if a lender has a maximum LTV ratio of 80%, this means that you’ll only be able to borrow 80% of the equity in your home. In this case, if your home equity was $180,000, you’d be able to borrow up to $144,000.
Lenders may also have other limitations that can include credit scores, income and debt-to-income ratio that would impact the amount of equity that can be borrowed. Bear in mind that accessing your home equity (such as using a home equity loan) also comes with potential additional costs such as closing costs, lender fees, interest charges, and so on.
How Soon Can You Pull Equity Out of Your Home?
Each home equity option has its own criteria with regards to using home equity. In other words, the timing of when you can begin to use it will depend on the method you have chosen. It’s important to consider each option and its processing times and requirements.
Here’s a general overview of when each method will let borrowers get access to their home equity…
Home Equity Loan and Home Equity Line Of Credit
Processing Time: The application and approval process for a home equity loan or HELOC typically takes a few weeks. This includes gathering necessary documents, credit checks, property appraisal, and underwriting.
Accessing Equity: Once approved, borrowers can usually access the funds within a few days to a week after closing.
Cash Out Refinance
Processing Time: A cash out refinance involves replacing the existing mortgage with a new one for a higher amount. The cash out refinance process usually takes several weeks and includes similar steps to getting a traditional mortgage.
Accessing Equity: After the cash out refinance is completed, the funds from the cash out portion of the refinance will be available to a borrower within a few days to a week.
Processing Time: The process of obtaining a reverse mortgage typically takes a few weeks. It involves counseling sessions, property appraisal, and underwriting.
Accessing Equity: Once the reverse mortgage is finalized, borrowers can access the funds in a lump sum, line of credit, or as a fixed monthly payment, depending on the chosen payment option.
Benefits of Taking Equity Out Of Your Home
There are several significant benefits for homeowners who choose to use the equity in their homes. Here are a few of the most significant benefits:
- Access to cash: A home equity loan or other method of tapping into home equity can provide a cash lump sum or line of credit for homeowners. This can be used for various purposes and allows homeowners to gain easy access to extra cash.
- Lower interest rates: Home equity loans, HELOCs and cash out refinances often offer lower interest rates compared to other types of loans such as personal loans or credit cards. This means that borrowers can save a significant amount on interest over the loan term.
- Tax advantages: Sometimes the interest that is paid on home equity loans, for example, may be tax-deductible. This can be a saving for borrowers over time.
- Retain home ownership: By using the equity in a home, borrowers can get access to extra funds while still retaining their homeownership. This means that they can continue living in the property and enjoying the benefits of owning a home, while gaining access to funds for other projects.
- Flexible usage: The cash obtained from home equity can be used for any purpose. This allows borrowers the freedom to do whatever they choose with their money, such as home improvements, traveling or education.
- Debt consolidation: Using your home equity is a good way to consolidate debt. For example, personal loan or credit card debt can be paid off using a home equity loan, and then the debt is all in one place instead. This means only having one monthly debt repayment.
- Fund investment opportunities: Homeowners can use their home equity to fund other investment opportunities. For example, a home equity loan can be used to provide the down payment on an investment property. This opens up new doors for homeowners to become real estate investors and generate profits from their new properties.
- Emergency funds: Establishing a home equity loan or HELOC as a financial fallback, is a good way to create peace of mind in the event of an economic crisis. This can be easily accessed in case a homeowner needs funds quickly.
Drawbacks of Taking Equity Out Of Your Home
While home equity provides homeowners with a host of benefits, this strategy should still be entered into with careful consideration and adequate research as there are some risks and drawbacks.
- Additional debt: Tapping into your home equity means taking on more debt, so it’s important to make sure that this debt is going to be managed, or borrowers can get themselves into hot water financially.
- Risk of foreclosure: Using home equity loans of some sort generally means that the property itself is used as collateral for the loan. So, in the event of the homeowner defaulting on the loan, they will be at risk of foreclosure on their home.
- Closing costs and fees: There are additional costs that come with accessing home equity, these include loan origination fees, closing costs, and other possible charges. These costs can add up and reduce the amount of cash you receive from the equity withdrawal. Closing costs are one of the costs most often forgotten about.
- Higher interest rates: While home equity loans, HELOCs and cash out refinances offer lower interest rates than some other loans, they still have higher interest rates than traditional loans. This means that borrowers will end up paying over time for these loans.
- Longer debt repayment: Home equity loans, and other loans that make use of home equity will often extend the repayment period of the loan. This means that borrowers will be paying off debt over a longer repayment period, which means more interest to be paid and a longer debt commitment.
- Threat of negative equity: If the property’s value decreases, this can leave homeowners in a problematic situation. A situation can arise where the outstanding loan balance is more than the home’s market value, and this can limit the reselling options.
- Risk of overextending: Home equity loans, HELOCs and cash out refinances can give borrowers access to a large amount of funds, which they can end up overusing. This can lead to financial strain and issues paying back the loan.
Alternative Financing Methods To Consider
Some other financing methods that borrowers can consider include:
Hard money loans: These are a good option for real estate investors who wish to get access to fast funding for a real estate project. Hard money lenders offer short-term loans with more flexible lending criteria. These loans are based on the property itself, and the borrower’s personal financial history is of less importance.
Home Equity Sharing or Fractional Home Ownership: Some companies offer home equity sharing programs where they provide cash in exchange for a share of your home’s future appreciation. This means when you sell your home, you’ll give the company a percentage of the proceeds.
Crowdfunding: This is a method where individuals or businesses can gather small sums of money from a large pool of people to support a specific project or venture. Crowdfunding platforms offer different types of funding options, such as reward-based (offering non-financial incentives to backers), donation-based (receiving contributions without financial returns), and equity-based (granting investors ownership stakes in the business).