Sixty-three percent of properties under U.S. homeowners with mortgages saw a rise in their home equity in the second quarter of 2021. According to data collected by CoreLogic, the equity increase adds up to around $2.9 trillion since Q2 of the previous year.
Based on this data, the average equity gain for every borrower totals $51,500. This extra equity gives homeowners an opportunity to get cash without having to sell assets, take out additional loans, or find ways to increase their regular income.
But whether or not your equity has risen this year, there are many ways you can get cash from your home equity. In this article, we’ll be talking about the options that you may have.
First, let’s define what home equity is.
What is Home Equity?
Home equity refers to the property’s current market value minus the outstanding balance of all liens attached to it. Simply put, it is the homeowner’s unencumbered interest in their home or the portion of the real property that they own.
Home equity is not fixed. It can fluctuate over time as the market changes, which causes an impact on the property’s value. That said, your home equity can rise and fall depending on current market conditions.
How Can You Get Cash From Your Home Equity?
There are several ways you can get cash from your home equity, including home equity loans, home equity lines of credit (HELOCs), reverse mortgages, and cash-out refinancing. Every option has varying qualifications, advantages, and disadvantages. To figure out which one suits your needs the most, you have to know how each method works.
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Home Equity Loan
A home equity loan, home equity installment loan, or second mortgage is a type of loan that allows you to borrow against the equity that you have. The amount that you can borrow depends on the difference between your home’s current market value and the mortgage amount that you have yet to pay.
Typically, home equity loans have fixed interest rates and set repayment terms, similar to a traditional mortgage. With a home equity loan, you receive the funds in one lump sum and repay the amount within a set number of years (usually 5 to 15 years).
Requirements
The general requirements for a home equity loan are as follows:
- Your home equity must be greater than 20% of your home’s value
- You have verifiable income history for at least two years
- Your credit score is above 600
- Your debt-to-income ratio is lower than 43%
- You have a good payment history
Some lenders may be lenient with these requirements for borrowers who have low credit scores or unstable incomes. However, it is not uncommon for these “high-risk” borrowers to only high-interest equity loans.
Advantages of a Home Equity Loan
Easy to obtain. A home equity loan is relatively easy to obtain since it is secured debt (the equity in your home serves as the collateral). If you meet or surpass the requirements, you also have a higher chance of securing a low-interest home equity loan.
Large payout. If you want to use the money to pay for large expenses, a home equity loan may be a good choice. Since the proceeds are given in one lump sum, you receive the money that you need all at once. Most borrowers use the money to pay for home renovations, debt consolidation, and college tuition, just to name a few.
Disadvantages of a Home Equity Loan
Risk of debt. Unless you are financially responsible, taking out a home equity loan can be risky, especially if you plan to use the proceeds to pay off other debts. Basically, it is like taking out a mortgage all over again, which can lead to a cycle of debt.
Cash-out refinance
Mortgage refinancing is the process of taking out another loan to pay for your current mortgage.
Essentially, you are replacing your old loan with a new one. However, a cash-out refinance is not the same as a traditional refinance. In a cash-out refinance, the new mortgage is larger than the balance on the old mortgage, allowing borrowers to receive the difference in cash.
There are three major options for cash-out refinancing, including conventional loans that can allow you to borrow up to 80% of your property’s value; FHA loans that also allow you to do the same but typically involve upfront payment of loan fees; and VA loans for qualified personnel and their surviving spouses that can allow individuals to borrow up to 100% of their home’s value.
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Requirements
The general requirements for a cash-out refinance are as follows:
- Your home equity must be greater than 20% of your home’s value
- You have verifiable income history for at least two years
- Your credit score is above 600
- Your debt-to-income ratio is lower than 43%
- A new home appraisal
- A loan-to-value ratio equal to or less than 80%
Advantages of a Cash-Out Refinance
Modifying the mortgage. You can use cash-out refinancing to reduce your monthly mortgage payments, obtain a lower interest rate, renegotiate loan obligations, and receive cash.
Extra cash. The main purpose of a cash-out refinance is to let you access extra cash. This can be extremely useful if you are planning to renovate your home, pay off some of your debts, pay for higher education, and other large expenses.
Disadvantages of a Cash-Out Refinance
Higher interest cost. Since you’ll be redoing the mortgage, you ultimately end up paying more lifetime interest costs.
Longer loan life. A cash-out refinance is basically a new loan, which means that you’ll be paying off the mortgage for a longer amount of time. This can help lower your monthly mortgage payments, but you will be paying off your debt ten or more years longer.
Risk of foreclosure. A cash-out refinance is a secured loan that uses your home as collateral, hence the risk of foreclosure in case you can no longer keep up with payments.
Reverse Mortgage
A reverse mortgage is a type of home equity loan that is only available to borrowers that are 62 or older. However, unlike the loans that we have mentioned above, a reverse mortgage does not require repayment until the borrower dies, moves away permanently, or decides to sell their home.
The maximum amount of money that you can obtain from a reverse mortgage depends on the home’s appraised value as well as the borrower’s age at the time of application. A borrower can receive the funds through a lump sum, a line of credit, tenure payments, or term payments.
The most common type of reverse mortgage loan is a Home Equity Conversion Mortgage (HECM). It is insured by the FHA, which means that borrowers are protected from lender failure.
Requirements
These are the general requirements for a reverse mortgage. Again, it can vary from lender to lender.
- You are at least 62 years old
- You have at least 50% equity in your home
- The property must be your principal residence
- You must agree to meet loan obligations (paying property taxes, keeping the home in good shape, etc.)
HECMs typically have additional requirements, such as meeting with a reverse mortgage counselor approved by the Department of Housing and Urban Development (HUD).
Advantages of a Reverse Mortgage
No required monthly mortgage payments. If you still owe money on your mortgage, taking out a reverse mortgage means that you are no longer obligated to make a monthly mortgage payment.
Additional income. A reverse mortgage can be a great option for retirees looking to make extra income. Proceeds from a reverse mortgage, when received in a lump sum, can also be used for large expenses, such as home renovations, medical bills, etc.
Ownership retainment. You get to keep full ownership of the home until the loan balance is due.
No taxes. The IRS does not consider proceeds from a reverse mortgage as income, making it tax-free.
Disadvantages of a Reverse Mortgage
Risk of foreclosure. Just like any other loan on this list, there is always a certain level of foreclosure if your home is the collateral. As long as you keep up with your loan obligations, however, the risk of foreclosure is very minimal.
Relocation difficulty. One of the requirements of a reverse mortgage is that the mortgaged property must be your primary residence. If you plan to move elsewhere in the future, taking out a reverse mortgage on your current home may not be a good idea.
The Bottom Line
As you can see, there are many ways you can gain access to your home equity and receive substantial amounts of cash. Each option has its own requirements, pros, and cons, which means that there is no perfect choice for everybody.
If you want to learn more about how to get cash from your home equity through a reverse mortgage, talk to our experts today (844) 230-6679 or learn from our learning center here.
Read more Frequently Asked Questions about reverse mortgages.