3 Ways to Leverage your Home's Equity

We describe 3 options you can use to pull equity from your home as cash: cash-out refinancing, HELOC, and reverse mortgage.
POSTED ON:
October 5, 2020
UPDATED ON:
October 5, 2020
Category:
Financing

One of the benefits of owning a home is the potential to pull equity as a financial tool. Though most lenders will require at least 20% of equity kept within the home, they certainly can’t require you to spend the cash you get a certain way. This is great for emergencies, debt consolidation, and/or building more assets for the future.

(The chart shows an annual estimate of the tappable equity in the United States, since 2004. Last bar is the estimate for Q1 of 2020 ONLY. Source: Black Knight)

 

According to HousingWire, the total tappable home equity (the amount that homeowners borrow against their home, while still leaving the 20% required) was at a record high in the 1st quarter of 2020: $6.5 trillion. Chances are, there’s a piece of that huge pie just sitting in your home. In this blog, we’ll discuss 3 ways to leverage your home’s equity: cash-out refinance, home equity line of credit (HELOC), and reverse mortgage. 

What is cash-out refinancing?

Similar to a traditional refinance, cash-out refinancing is a process that replaces your current mortgage loan with a new one. The key difference is - the new loan will be more than what you currently owe on your house. This new loan will pay off your remaining balance on the house, while the extra (reduced a bit due to the 20% equity requirement mentioned above) gets cashed out to you in a lumped sum. A cash-out refinance is most ideal for high equity homes and if market rates are lower than your current rate.

What’s a HELOC?

HELOC is short for home equity line of credit. With a HELOC, a line of credit is created using your home’s equity as security. Similar to a credit card, you’re able to withdraw from your HELOC on an as-needed basis (as opposed to the cash-out refinance that gives a lump sum) within the draw period. Using HELOC is most ideal for debt consolidation, as a source of an emergency fund, or to take advantage of great opportunities that become available.

There are two key terms/periods to a HELOC that you should know:

  • Draw period: This is the period of time that you’re allowed to pull from a HELOC. During this period of time, you’ll be required to make interest only payments on the amount of money you have actually taken out of the HELOC. Once a draw period ends, you can’t borrow any more money from the line of credit. A draw period can be as long as 10-30 years, depending on the terms agreed upon between you and the provider.
  • Repayment period: As it suggests, this is the time you’re required to make fully amortizing payments towards what you borrowed from the HELOC.

What’s a reverse mortgage?

Unfortunately, this is only for borrowers 62 years of age or older. We like to refer to this loan as a “retirement loan.” This is a loan where you can convert your home's equity to cash on hand. Payments are not required until you either pass or move out of your home. If you do choose to make payments, you can just as easily ask for the money to be returned to you in the unlikely even you need it in the future.

A very common misunderstanding of this loan is that you are selling your home to the bank - not true. This is a government-insured loan that you or your heirs can never owe more than the property is worth. It’s a regular loan that you simply do not have to make payments on. We recommend this for use as additional income and to cover extra health care costs, or to simply enrich your life by not making a housing payment and enjoying the reduced debt load.

(This is a slide from one of our home-buying webinars - titled "financing your home." You can click through this link to watch the section about reverse mortgage.)

But… am I allowed to do what I want with the extra money?

You - as the borrower - are welcome to use the extra money from any of the outlined loan options above anyway you'd like! We put together a short list of suggestions below, in case you needed extra ideas. We’re not saying one is better than the others. These are simply suggestions, opposite of spending the extra money on items that may not appreciate in value.

  • Remodeling your home and/or build out a casita: In Spanish, “casita” means “small house”—in real estate, it describes a small, detached suite built on the same lot of a single-family home. Either option could potentially increase the overall value of your home. If you decide for the casita, the additional living space can be used as a rental for additional income.
(David and Deborah's casita. It features the first living residential roof in Redlands. Want a tour? Let us know!)
  • Open an IRA (Roth or traditional): IRA is short for “individual retirement account.” You can always find a financial institution through your favorite search engine – here’s a great overview from Investopedia. The keys with an IRA is to start early and to determine whether you want to bean active or passive manager of your account.
  • Consolidate/Manage multiple sources of debt: If you have several debt channels, you can leverage the equity from your home to pay all/most of them off. This way, you’re only making one payment – much easier to manage and remember.

Reminder: We are NOT personal finance gurus nor are we saying one is better than others. These are only suggestions opposite of spending on items that may not appreciate in value. We hope you learned something new from this blog! Let us know if there are topics you'd like for us to write about in the future.

 

 

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