What’s the Best Way to Access Your Home Equity?

If you’re struggling with debt or are in a bind for cash, you might want to consider tapping into your home equity. As a homeowner, you may have spent years or even decades building equity in your property. It may be time to use it to your advantage.  

Key takeaways

• There are five ways, or tools, you can use to tap into your home equity.

• These tools include: a cash-out refinance; a home equity line of credit (HELOC); a home equity loan (HEL); a reverse mortgage; and a home equity agreement (HEA).

• As with any financial service, some of these products may be a better fit than others. The best way to access your home equity will depend on your personal circumstances and financial goals.

What is home equity?

Home equity is the difference between the market value of your home and any outstanding loans against the property. The following video explains home equity in greater detail.

5 ways to access your home equity

Depending on your circumstances, some ways to tap into home equity could be better than others. Be sure to consider and compare each of the five tools.

1. Cash-out refinance

How it works

A cash-out refinance is an option in which a new mortgage replaces your current one. The new mortgage loan has a higher amount than what is owed on the previous mortgage, so you’ll receive that additional amount in cash.

Who it’s good for

You can use the cash from a cash-out refinance for any purpose. Has your financial situation taken a turn for the worse? Are you struggling to keep up with outstanding debt or your monthly credit card payments? Have your student loan debt interest rates reached a record high?

If you answered yes to any of these, cash-out refinancing may be a good idea. It can help you pay off existing debt with high interest rates, effectively shifting your debt to a better position – as long as you find a cash-out refinance option with lower interest rates than the rates on the debt you’re planning to pay off. 

What to Watch out for

Interest rates. If cash-out refinancing won’t _decrease _your interest rates, don’t do it!

Closing costs and monthly payments. You’ll need to pay closing costs on a cash-out refinance. These can be around 2-5% of the loan amount, on average. The monthly payments can be higher than what you had previously been paying.

Cancellation and prepayment penalties. If you want to pay off your loan early, you may incur hefty penalties. As with any mortgage, watch for these.

2. Home equity line of credit (HELOC)

How it works

Unlike cash-out refinance, a HELOC doesn’t replace your existing mortgage. It acts more like a credit card that uses your home equity for funding and allows you to borrow money over a period of time. 

Who it’s good for

A HELOC loan can be a good option if you aren’t sure how much money you’ll need or when you’ll need it, as it gives you access to a long-term, revolving credit line – sometimes up to 10 years.

What to watch out for

Your credit line. If your home’s value decreases or your financial situation worsens, your creditor may lower or revoke your credit line. 

Risk of foreclosure. If you default on your HELOC, you risk foreclosure.

Interest rates. Most HELOCs are variable-rate loans, which means that the interest rates and monthly payments will go up if market interest rates do.

Fees. HELOCs don’t typically have signing, or closing, costs. However, there may be minimum draw requirements. Also, determine if there are any prepayment penalty or annual fees.

3. Home equity loan (HEL)

How it works

Think of a home equity loan as a second mortgage. It enables you to borrow against your home equity, and uses your home as collateral to guarantee the loan. 

Who it’s good for

If you have high short-term expenses like medical bills, college tuition, or a home renovation project, a home equity loan can be a good choice, as you will receive a large lump sum. You could also use the funds to help you consolidate your debt, as interest rates will usually be lower than rate on credit cards and other unsecured debt.

What to watch out for

Interest rates. A home equity loan carries a fixed interest rate, which will generally be higher than the rate on a HELOC. However, both will have lower interest rates than personal and other unsecured loans.

Signing (Closing Fees). Typical fees are around 3-5% of the loan amount.

Risk of foreclosure. Because your home serves as collateral, defaulting on a home equity loan runs the risk of foreclosure. 

4. Reverse mortgage

How it works

If you are 62 years of age or older, you may be able to use a reverse mortgage to tap into your home equity and supplement your retirement income. The loan only becomes due once the effective period expires, which is usually when the homeowner moves or passes away.

Who it’s good for

If you’re looking to delay drawing on your Social Security, a reverse mortgage may be a good fit. There are no monthly payments, and you can continue to live in the property for the life of the loan.

What to watch out for

Eligibility requirements. To qualify for a reverse mortgage, you must typically own your home or have a single primary lien (a legal right or claim against the property by a creditor – such as your mortgage lender).

Homeowner expenses. Under a reverse mortgage, you remain responsible for any housing-related expenses, such as property taxes and homeowners insurance. If you can’t keep up with the payments, you run the risk of foreclosure.

Your health. If you have to move into an assisted living facility or a nursing home for 12 months or more due to health issues, the loan will become due.

Inheritance plans. If you intend to leave your home to your family, keep in mind that they will inherit not just the property, but also any outstanding debt – including a reverse mortgage. What’s more, the creditor will expect full payment after you pass away.

5. Home equity agreement (HEA)

How it works

With HEAs, you get cash now in exchange for a share of your home equity. An HEA is not a loan: there are no interest rates or monthly payments. Instead, the HEA service provider will receive a percentage of the proceeds when you sell your home in the future.

Who it’s good for

You may benefit from a home equity agreement if you:

• Need a lump sum of cash in the short term

• Have a low credit score

• Have a high debt-to-income (DTI) ratio

• Don’t qualify for other mortgage or consumer finance products (such as personal loans)

• Are debt-averse

• Can’t afford, or don’t want, additional monthly payments or interest that come with a HEL or HELOC

What to watch out for

• Your home equity. If you haven’t accumulated at least 25% equity in your property, you may not qualify for an HEA. 

• Your future plans. Do you plan to live in your home for a decade or more? Most home equity agreements have an effective period of 10 years. After that time, you would need to sell the property, buy the HEA provider out, or take out a new loan to settle the agreement.