As home values have soared all across America, homeowners in the U.S. are enjoying record levels of home equity. And unprecedented abilities to tap their homes for cash in three ways: cash-out refinancing, home equity lines of credit, and home equity loans. Let’s look at all three to see which might be the right way for you to harness the power of your home’s equity.
But first, how much increased home equity do Americans have?
A staggering amount. Close to two-thirds of all homeowners in America have mortgages, and they’ve seen nearly 30% increases in home equity year after year, collectively equaling a gain of a whopping $2.9 trillion from the second quarter of 2020 to the second quarter of 2021 alone. That comes out to a gain of over $50,000 for each borrower. And that’s just the average; borrowers in some states have seen eye-popping gains, such as those in California ($116,300 per borrower), Washington ($102,900), and Idaho ($97,000).
1. Cash-Out Refinancing
The basic idea here is to refinance the mortgage you have for more than the current amount and take out the difference in cash. If you’re looking for the maximum amount of cash you can get, this may be the best way to go. What would it look like? Say, for example, you have a home that’s valued at $300,000 and you owe $200,000 on the mortgage, leaving you with $100,000 in home equity. As lenders will often allow you to borrow up to 80% of that equity, you can feasibly borrow $80,000.
But most people don’t go for the maximum equity of a home, staying somewhat more conservative. Say $50,000 here. To pocket that amount, you refinance to get a new mortgage for $250,000, and at closing, you get a check for $50,000. Minus costs. Keep in mind that closing costs usually run between 3% and 6% of the total loan amount. So, with this example of a new $250,000 loan, you can expect to pay between $7,500 and $15,000 in costs, which you can pay in cash or roll the costs into the mortgage.
2. Home Equity Credit Line
A HELOC, or home equity line of credit, works somewhat like a credit card, though almost always with lower interest rates than you would find with credit cards. Instead of one lump sum, with a HELOC you take out multiple loans over the span of the mortgage loan, which is usually ten to 20 years. After his period, the balance, principal and interest, must be paid back. A home equity line of credit resembles a credit card so much that some lenders issue HELOC cards for borrowers to easily get the cash. This method of tapping into a home’s equity often works best when the borrower is looking to get a lower amount of cash.
With HELOCs, it’s common for lenders to lend up to 80% of the appraised value of a home, usually without closing costs. Though you may have to pay an appraisal fee, often in the $300 to $400 range, to assess your home’s current value. Plus, most HELOCs have annual fees, usually around $100 or less. Home equity lines of credit differ from cash-out refinancing in that HELOCs usually have lower requirements for eligibility and somewhat higher interest rates. Don’t need cash right now? You might consider setting up a HELOC just to have it in place in case an emergency calls for fast cash.
A typical setup of a HELOC splits into two periods: the draw stage and the repayment stage. During the first, which often runs between five and ten years, you make only interest payments on the money you withdraw. In the repayment stage, typically ten to 20 years, you can no longer draw money and the HELOC becomes a straightforward loan that you repay with interest.
3. Home Equity Loan
Commonly known as a second mortgage, a home equity loan is arguably the most direct way to tap your home for cash. You borrow a lump sum against the value of your house and immediately start repaying the interest. The interest rate is typically fixed and today’s historically low interest rates make home equity loans attractive options for many homeowners. Like cash-out refinancing, you’ll need to consider closing costs with home equity loans, which are often in the 2% to 5% range. Back to our example of a $250,000 loan, these costs would typically be between $5,000 and $12,000. Lenders often allow you to borrow up to 85% of the appraised value of a home, less what’s owed.
A slow-and-steady approach, home equity loans are paid back over long periods, usually between 15 and 20 years, though they can go as high as 30 years. To qualify, lenders usually look at the financials of a potential borrower as they would for first-time mortgages — one’s income, credit score, and debts. And most lenders want at least 15% equity to make a home equity loan.
Consider What the Cash is For
This may seem like a no-brainer, but the prospect of fast-and-easy cash can be a temptation that clouds judgment. So, you’ll probably want to ask yourself, What do I want this money for? If the answer is something like taking a luxury vacation on a Caribbean island, then you might want to rethink your priorities. Tapping into your home’s equity is a financial decision that will involve repercussions and responsibilities for years, even decades. For many borrowers, renovation loans for home improvements that increase the values of their homes can be a better investment in the long run.
With each of these three options, bear in mind that they come with fees and the extra burden of higher monthly payments than you currently have. If that sounds manageable, getting cash out of your home right now can be a wonderful option. If not, you can always just let your home equity continue to build and feel secure with the knowledge that the cash will be there should you truly need it.