For many, the initial plan is never to take cash out of their homes. We want to pay them off already! But what if you’ve built up equity? How do you gain access, and is it even a good idea? The answer can sometimes be confusing, so here are a couple of options:
Option #1: HELOC (Home Equity Line of Credit) Or HELOAN (Home Equity Loan)
With a HELOC, you’re borrowing against the equity available in your home. Similar to credit cards, you only pay interest if you borrowed from them. If you borrow from it, once the balance is paid, that credit will become available. Typically the borrow-from period lasts about ten years, and then it converts to a 20-year amortization at a fixed rate most of the time.
Perhaps the biggest pro of a HELOC is that you don’t have to take money out in a lump sum. Thus you’re not paying interest on the money you aren’t actively using. Typical uses of a HELOC would be for emergency funds, home improvement projects, and sometimes even to purchase more real estate. Banks typically will also allow you to borrow up to 80% to 95% of your home’s value. Be careful, though; the higher you go on your loan to value (LTV), the higher your interest rate on this line of credit will also generally go. Closing costs are also minimal and/or sometimes paid by the bank you’re obtaining them from.
The biggest con of a HELOC is generally the interest rate. While the payments usually interest only on your outstanding balance, it is usually in the 2nd position on your home, which means should the market crash, they’re the 2nd ones that get paid should your home foreclose. Therefore, the rates are a little higher and are generally tied to the Wall Street Journal Prime Rate, which surged rapidly in 2022 with the Fed raising rates.
Option #2: Cash-out refinance
With a cash-out refinance, you’ll pay off your current mortgage and take some additional cash.
Cash-out refinances are best used by consolidating debt, such as credit cards and student loans, remodeling if you have plans in place already, and purchasing more real estate, such as a vacation home or short-term rental. Other reasons to choose this option over a HELOC would be to consolidate your mortgage payment into one payment and also to maintain a fixed payment that won’t fluctuate.
The caveat to cash-out refinances? Generally, you’re more limited on the cash you can take out relative to your home value. For example, for the HELOC option above, sometimes you can take out up to 95% of the value of your home. For cash-out refinances, generally, this is limited to 80% loan to value (Though some other options do exist, they’re more difficult to find and usually not cost-effective)
Both of these are great options depending on your scenario. Please let us know if you’d like us to take a look at your scenario and help you choose the right option.
