Understanding How to Pay Back Home Equity

Key Takeaways: 

• Tapping your home’s equity can provide you with needed cash, but make sure you understand the terms of the option you choose and make an “exit plan” before entering into any agreement. 
• Loan options (home equity loan, home equity line of credit, cash-out refinance and reverse mortgage) will require a monthly payment, and sometimes even a balloon payment. 
• With the no-loan option (home equity agreement), you will buy back your equity – and have no monthly payment. 

You know “there’s no such thing as a free lunch.” It’s true with home equity, too. There’s no “free” money. Tapping your home equity can give you access to much-needed cash, but you’ll eventually need to pay back the money you pulled from your home. Planning and forethought on how you’ll make your exit – whether you are considering a loan-based option or a no-loan home equity agreement – is key to do before you make your entry into any agreement. Doing so will allow you to avoid overextending, help you build your financial future and give you peace of mind. 

Home equity loan 

Repaying the proceeds from a home equity loan (HEL) is direct and straight-forward. HELs come with a fixed interest rate and fixed payments. They stay the same over the life of the loan. You’ll repay the set amount monthly over a set time period – usually five to 20 years.  

Incorporate this set monthly amount into your household budget. Pay and prioritize it as you do your mortgage payment. Since your home serves as collateral for the loan, you risk losing it if you can’t make payments. 

It may be possible to pay your HEL off early. However, some lenders impose pre-payment penalties. Others may allow pre-payment of the principal, but still charge interest for the full term. Check with your lender for specifics. And remember it’s always best to read and understand the fine print of your agreement before signing on the dotted line. 

Home equity line of credit   

With a home equity line of credit (HELOC), budgeting gets a little trickier because this type of loan typically has a variable interest rate. That means the monthly payments may change over the life of the loan. Your lender will provide a range of how low – and high – the interest rate and payment may go. Some lenders do offer fixed-rate HELOCs, but most are still based on a variable rate. 

Some homeowners include the current payment into their budgets, and keep close tabs on changes to make necessary adjustments. Others budget for a higher amount than they currently are paying and put the excess into designated savings. That way, they will have a reserve to draw on when (or if) the interest rate (and the payment) increases. If you do have a variable-rate HELOC, it can be smart to pay it down as quickly as possible to avoid major interest rate surprises. 

Be aware that some HELOCs come with a balloon payment – a large, lump-sum payment due at the end of the term. These payments could be twice as much as a regular payment, or they could total tens of thousands of dollars. If your HELOC has a balloon payment, you’ll be wise to budget monthly for it over the life of the loan, and have the amount saved up and ready to go. Otherwise, producing the full amount when due can be a challenge, at best  

Cash-out refinance 

If you are looking at a cash-out refinance, you’ll be replacing your mortgage with a new one, versus adding another loan. Homeowners often consider a cash-out refinance when mortgage interest rates fall – a few points or more – below their current rate. Since many borrowers in this position choose to borrow a larger principal sum in the new mortgage, it’s possible that the monthly payment could actually be higher – even if the interest rate has decreased. 

Make sure you understand the terms and exact monthly payment and include that in your budget. 

Reverse mortgage 

In a reverse mortgage, you won’t have monthly payments since the lender is paying you. But that doesn’t mean it’s not a loan. A reverse mortgage loan must be paid off when the borrower – who must be at least age 62 – passes away, moves out (for 12 months or more for any reason) or sells the home. Be sure to thoroughly research, and fully understand, the terms, and whether the options for paying back the loan work for you. 

Home equity agreement 

Since a home equity agreement (HEA) is not a loan, you won’t have monthly payments. However, the cash you receive upfront is in exchange for a portion of the future value of your home. Going into such an agreement, it’s important to have a plan for how and when you’ll buy back your equity. 

When you sell your home – whether at the end of the HEA term (typically 10 years) or any time before that – the HEA provider will take its portion. You will share the proceeds with the provider based on the terms provided in your agreement (e.g. 10% of your equity for 20% of your home’s future value).   

Alternatively, with a provider such as Unlock, you can buy back your equity at any time during the term without penalty. This “partial buy-back” option provides flexibility for a homeowner, decreasing the amount you’ll need to pay when you sell the home or settle the agreement in full.   

Many homeowners use HEA proceeds to pay off unsecured debt (including credit card debt). Eliminating those debt payments gives them additional cash every month – cash they could save to do an early buy-back of their equity. 

You can also choose to buy back your equity at the end of the term using cash on hand. Your HEA provider will require an appraisal at that time to determine the value of your home and their corresponding equity percentage.  

Conclusion 

Ready to access your home equity? Do some pre-planning and budgeting for how you’ll pay off your loan or, in the case of a home equity agreement, buy back your equity. Your wallet and financial future will thank you.