If you require a large sum of money for a major home renovation, debt consolidation, or an anticipated medical bill, you may be tempted to refinance your home. While refinancing may be the quickest way to unlock the cash you need, going this route comes with several disadvantages. For one, you’re on the hook for closing costs, which include appraisal fees, credit report fees, origination fees, attorney fees, and more.
However, you can tap into the equity you’ve built on your home without having to refinance or sell your property. Here’s how to get equity out of your home without refinancing, how much equity you can access, and how soon you can take it out.
The Basics of Home Equity
Home equity is one of the best advantages of owning a home. Home equity offers an escape from monthly payments that you will always have to make if you decide to rent. Here’s an introductory guide to how home equity works.
What is Home Equity, and How Can You Benefit From It?
Home equity reflects how much of your property you own. When you take out a loan, you initially only have equity equal to the down payment. Homeowners build up equity each month by making mortgage payments.
While you work hard to build equity, your property will do some of the work for you. If your home value goes up, that extra value turns into home equity.
Homeowners have many ways to build up home equity, but why is it important? Getting closer to full equity over your home means you won’t have to make mortgage payments anymore. Since a house is the most significant expense for most people, you’ll have more freedom in your budget.
You can also tap into home equity through a home equity loan or a line of credit. Qualifying retirees can also take out reverse mortgages on their primary residences. A reverse mortgage is a financial product that initiates monthly cash payouts based on the equity remaining in your home.
It’s also possible to use a cash-out refinance to tap into your home equity. This financing method allows you to access more capital while changing the terms of your current loan. If your credit score and income have been approved since you first got a mortgage, you can end up with a lower rate. Extending the loan’s duration will reduce the monthly payments and can make homeownership more affordable.
How to Calculate How Much Equity You Can Access
If you plan to get equity out of your home, it’s essential to understand the amount of equity you currently have. To determine how much you have in your home, find the difference between your home’s appraised value and the amount you still owe on your mortgage.
Let’s say your home’s market value is $350,000, your remaining mortgage is $150,000, and your home equity is $200,000. The higher the amount of equity in your home, the more financing options you’ll have.
It’s important to note that lenders are more interested in the amount of equity you already own than your creditworthiness. This is because your home acts as collateral, meaning the lender can foreclose on your home to recoup the losses if you default.
Most lenders have a maximum loan-to-value ratio that you can have between your primary mortgage and your secondary mortgage. If the maximum LTV ratio is 80%, then you can only borrow up to $400,000 for a $500,000 home. If you already have a $250,000 mortgage balance, you can only borrow an additional $150,000 to reach $400,000.
If your home’s value increases over time, you can borrow more money while maintaining an 80% LTV ratio. Some lenders are more flexible and allow homeowners to have 95% LTV ratios.
How Soon You Can Take Equity Out of Your Home
Whether you recently purchased a house or have been owning one for a while, you can tap into the equity in your home anytime. There’s no specific timeframe for taking equity out of your home, provided that you’ve built up enough equity.
For example, if you recently bought a home at $500,000 and paid a 20% down payment, which is $100,000, your home equity stands at $100,000. And if you’ve made mortgage payments, your equity will be higher.
Keep in mind that most lenders require at least 20% equity in your home and typically cap borrowing at 80% of a home’s value. So, the question isn’t how soon you can take equity out of your home but how much equity you’ve built.
Understanding What It Means to Refinance
A refinance can free up space in your budget and give you more flexibility. However, it’s important to consider how refinancing works and why it isn’t a good choice for everyone.
The Process of Refinancing
The process begins when you establish what you want to do with your refinance. Some of the possibilities include reducing your rate, getting a lower monthly payment, paying off your loan faster, getting cash out, or a combination of these choices.
You will have to shop around and compare rates from banks, credit unions, and online lenders. You will have to submit your personal identification, proof of address, income documents, and other information. Each creditor outlines their requirements.
A home appraisal is an integral part of the refinancing process. Lenders want to determine your home’s value before agreeing to any terms. Once you reach an agreement, you will receive a new loan. In some cases, you may need available cash for the closing costs. However, these costs can get rolled into the loan.
The Pros and Cons of Refinancing
Refinancing is a significant decision that isn’t right for everyone. These are some of the pros and cons to consider.
Pros:
- Get a new loan that can have a lower interest rate.
- Extend the loan’s duration to reduce monthly payments.
- Tap into your property’s equity.
- Free up space in your budget.
Cons:
- Lose your current mortgage even if you like the rate and terms.
- Potentially higher interest rates, especially if your credit score is lower.
- Stay in debt longer.
- Incur additional closing costs.
Ways to Get Equity Out of Your Home Without Refinancing
You can take equity out of your home in various ways. The most popular forms include home equity lines of credit or HELOCs, and home equity loans. Each option has pros and cons you should weigh when deciding the right one for you. These strategies let you preserve your existing mortgage.
HELOCs
A home equity line of credit (HELOC) is a type of second mortgage that allows you to borrow money using the equity that you’ve built in your home and receive the funds as a line of credit. Simply put, it is a revolving line of credit that gives you access to cash on a needed basis. Much like credit cards, you can draw as little or as much as you need up to a certain credit limit, repay, and borrow again. The good news with HELOCs is the flexibility they offer 一 you only pay interest on what you borrow.
Traditionally, HELOCs work on a 30-year model, a 10-year draw period, and a 20-year repayment period. If you choose an interest-only, you’ll be required to make interest payments only, and not the principal, during the draw period. Once the draw period expires and you enter a repayment period, you’ll begin to pay the principal and interest.
Home Equity Loans
Also generally known as a second mortgage, a home equity loan is a financing option that allows homeowners to borrow against their homes. Essentially, your home serves as collateral, meaning the lender can foreclose on your property to recoup the losses if you default.
Home equity loans often come as a lump sum of cash with a fixed interest rate. Like conventional mortgages, these loans have a set repayment period, where the borrower makes fixed, regular monthly payments. The amount you can borrow is based on the difference between the home’s current market value and the remaining mortgage balance. The amount of home equity loan you’ll get and the interest you’ll be charged depends on your credit score, repayment history, debt-to-income ratio, and other factors lenders look at.
Tapping into a home equity loan can be a great way to convert the equity you’ve built up into cash, especially if you want to put that cash into renovation projects that could increase the value of your home.
Reverse Mortgages
Reverse mortgages let you receive monthly payments from your home equity. This product is only available for retirees in primary residences. You must be at least 62 years old to use this product and need at least 50% equity in your home.
Applicants must speak with a reverse mortgage counselor before receiving this product. Reverse mortgages are also known as home equity conversion mortgages (HECMs). You can opt for a small lump-sum payment followed by monthly payments or start with monthly payments. There is a limit to how much you can borrow in the first year to ensure applicants do not burn through their home equity too quickly.
You have to fulfill a few requirements to maintain your HECM, such as keeping the property in good condition and always treating it as your primary residence.
