Alternative Ways to Get Equity Out of Your Home

Traditional home equity products, like home equity loans and home equity lines of credit (HELOCs), are often used by homeowners to get cash out of their property to fund things like renovation projects, home repairs, or debt payments. But they aren’t the only options to consider. A Home Equity Agreement (HEA) could be a great option for those who don’t want to add to their existing debt load or have an additional monthly mortgage payment.

This guide explores the most common alternative ways homeowners can pull equity out of their homes. You may already be familiar with home equity loans, HELOCs, and cash-out refinance, which will be discussed here. But this guide will also touch on other less traditional methods, like sale-leasebacks and HEAs. It will explain how each option works, the costs involved, and the potential benefits and drawbacks to consider when deciding which approach makes the most sense for individual homeowner circumstances and needs.

Introduction to Home Equity

Understanding the Concept of Home Equity

Home equity is a valuable asset that you build as you pay off your mortgage and as your property’s value increases. Simply put, it is the difference between your home’s current market value and your outstanding balance on your

current mortgage. The more you pay down your mortgage and the higher your property value rises, the greater your home equity will be.

How Home Equity Works

As you make mortgage payments, your equity in your home grows. It is essential to understand that the repayment period and interest rate on your mortgage will significantly impact the amount of equity you accumulate.

For example, mortgages with shorter repayment periods will allow homeowners to accumulate equity at a faster pace. However, having a higher interest rate may slow down your equity growth, as more of your monthly payment will be allocated towards interest instead of reducing the principal balance.

Another critical factor in determining your home equity is the market value of your property. As your home’s value increases, so will your equity. However, if your property’s value decreases, it will negatively impact your equity balance.

The Importance of Home Equity

Home equity can play a vital role in your financial journey.

Benefits of Having Home Equity

Home equity offers several advantages, including:

• Financial flexibility: As your home equity grows, it serves as a valuable financial resource that can be utilized to secure loans or lines of credit at lower interest rates compared to unsecured debt, like credit cards.
• Debt consolidation: Leveraging your home equity through a cash-out refinance or a home equity loan can help you consolidate high-interest debts into a single, lower-interest monthly payment that you can afford.
• Home improvements: Home equity allows you to finance significant home improvement projects, which can further increase your property’s value.
• Emergency fund: Accessing your home equity during financial emergencies can provide you with a lifeline when you need it most.

Risks Associated with Home Equity

While home equity has its benefits, it also comes with inherent risks:

• Loss of your home: Borrowing against your home equity might put your property at risk if you fall behind on mortgage payments. The lender could initiate the foreclosure process and take ownership of your home.
• Decreased home value: A significant drop in your property’s value could lower your home equity and make it challenging to refinance or sell your home.
• Increased loan amount: When you take out a home equity loan or a cash-out refinance, you’re increasing the overall loan amount you owe, which might lead to higher monthly payments or extend your repayment period.

Traditional Options to Access Home Equity

Here’s an overview of traditional home equity products commonly used by homeowners:

Home Equity Loans

With a home equity loan, you can borrow up to 85 percent of your home’s value minus the outstanding mortgage loan. So, if your home is worth $385,000 and you owe $295,000, you could potentially qualify for up to $32,250 ($385,000 * .85 – 295,000).

Loan proceeds are dispersed in a lump sum, and there are no restrictions on how they can be used. You’ll also get a fixed interest rate and make equal monthly payments over a set repayment term.

Home equity loans act as a second mortgage, so you won’t have to refinance your existing home loan. It’s equally important to know that your home could be at risk if you fall behind on loan payments.

Home Equity Lines of Credit (HELOC)

HELOCs and home equity loans are similar but have a few key differences. With a HELOC, you’ll get a pool of cash to draw against for a set period (or draw period). But if you get a home equity loan, the lender distributes the entire amount to you at closing.

Interest-only payments for the amount you withdraw are required on HELOCs during the draw period. When it ends, monthly installment payments for principal and interest begin and can fluctuate over time.

The significant variance is the interest rate – HELOCs generally come with variable interest rates, and home equity loans have fixed interest rates.

HELOCs are a good option for homeowners who prefer a pool of cash to borrow against as needed for a set period. You’ll only be on the hook for the amount you borrow and have control over the monthly payments. And you won’t pay interest on a lump sum payment.

Reverse Mortgage

Reverse mortgages are available to homeowners at least 62 years of age who want to tap into their home equity. You can choose from a fixed-rate reverse mortgage or an adjustable-rate reverse mortgage.

Fixed-rate reverse mortgages disburse loan proceeds as a lump sum. However, there are five disbursement options for adjustable-rate reverse mortgages:

• Term Payments: receive equal monthly payments for a set period
• Modified Term: receive access to a line of credit and equal monthly payments for a set period
• Tenure: receive equal monthly payments for a set period as long as you or your spouse live in the home
• Modified Tenure: receive access to a line of credit and equal monthly payments for a set period as long as you or your spouse live in the home
• Line of Credit: receive payments as needed until you reach the borrowing limit

While they are a relatively straightforward way to help senior homeowners get cash, reverse mortgages are very risky. You could lose your home if you default on property tax and insurance payments, fail to make repairs mandated by your lender, or reside in a location outside of your home for most of the year.

If you pass away and do not have a surviving spouse to maintain the home, your heirs could lose the home if they cannot pay the lender 95 percent of its appraised value.

Cash-Out Refinance

Cash-out refinancing allows you to access up to 90 percent of your home’s equity minus the outstanding mortgage balance. Here’s how it works: Assume you owe $345,000 on a home that’s worth $500,000 and want to do a cash-out refinance to tap into the equity. If the lender approves you for 90 percent LTV, you will get $105,000 ($500,000 * .90 – $345,000) at closing.

But here’s how it differs from home equity loans and HELOCs. Instead of repaying on a standalone home equity product or second mortgage, the lender will combine your outstanding mortgage balance and the cash you take out in a new loan that replaces your old one. The interest rate could be higher, and you’ll generally pay more each month.

Homeowners who want to consolidate debt or fund steep home improvements generally find these products very attractive. Paying off debt frees up money to meet other financial goals, and home renovations could substantially increase your property value.

Alternative Ways to Get Equity Out of Your Home

Are you having trouble getting approved for a home equity loan, HELOC, or cash-out refinance? Or perhaps you’d prefer to explore debt-free options that allow you to convert equity to cash? Consider these alternatives to get equity out of your home.

Sale-Leaseback

A sale-leaseback lets homeowners sell their property to an investor but continue occupying the home through a lease agreement. It’s a win-win for both parties – the investor can start earning rental income right away, and the lessee can turn a profit from the sale of the property without having to relocate.

Home Equity Agreement

A Home Equity Agreement (HEA) may be best if you don’t want to add extra debt or take a loan. This product is an agreement between an investor and homeowner that grants the investor rights to a share in the profits at the time of sale in exchange for a cash payment today.

Alternative Ways to Get Equity Out of Your Home: Weighing the Pros and Cons

Sale-Leaseback

Pros:

• You won’t have to relocate from your home.
• It’s a more ideal option than selling to get cash from the proceeds.
• The repair costs fall on the new homeowner.

Cons:

• You can no longer build equity since you don’t own the home.
• Your landlord could choose to end your lease
• You may be subject to capital gains tax.

Home Equity Agreement

Pros:

• You retain ownership of your home.
• You can access a large sum of cash quickly without assuming more debt.
• You avoid the stringent eligibility requirements that come with traditional home equity products.

Cons:

• You have to pay your fair share at a later date or sell your home, per the agreement.
• If the appreciation is substantial, you won’t derive the maximum benefit.
• Additional costs typically apply if you wish to terminate the agreement early.

How to Choose the Right Option for Accessing Home Equity

Factors to Consider

When deciding on the right option for accessing home equity, there are several factors to consider. Start by evaluating your current financial situation, including your credit score and income. They will affect your eligibility for different options and help you determine which is most suitable.

Next, think about your financial goals and how the equity will be used. You should have a clear purpose for the funds, whether it’s home improvement, debt consolidation, or to cover other expenses. Also, keep in mind the repayment period and how it may impact your monthly budget. In general, shorter repayment periods result in higher monthly payments but less interest paid over time.

Most importantly, compare interest rates, fees, and terms from different lenders. This will help you identify the better option while ensuring that it aligns with your financial goals.

Consultation with Professionals

Seeking advice from professionals, such as financial advisors or mortgage brokers, can bring clarity to your decision-making process. They can help you assess your financial situation and provide recommendations for the best options based on your unique financial situation.

Frequently Asked Questions (FAQs)