Do you have a substantial amount of equity built up in your home? If your home’s value has also increased, you could take out a home equity loan or home equity line of credit (HELOC) to pay off your mortgage and possibly save a bundle in interest. But which option is best?
Keep reading to learn more about how they work and the benefits and drawbacks of each. You’ll also discover an alternative that lets you tap into your equity without taking out a loan.
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What is a Home Equity Loan?
A home equity loan is a debt product homeowners commonly use to convert equity into cash.
How Do Home Equity Loans Work?
These loan products act as second mortgages and let you borrow up to 85 percent of the equity in your home. To illustrate, if you owe $245,000 on a home that’s worth $475,000, you could get a home equity loan for up to $158,750 ($475,000 * .85 – $245,000).
Upon approval, the lender sends the funds to you in a lump sum payment. You’ll remit equal monthly payments for the duration of the repayment term, usually five to 30 years.
How to Use a Home Equity Loan to Pay Off Your Mortgage
Before you use a home equity loan to pay off your mortgage, you want to ensure you’re getting a lower interest rate than you currently have. It’s equally important to confirm the amount you’re eligible for exceeds your outstanding mortgage balance.
Here’s an example of how it works:
Assume your home is worth $375,000, you owe $150,000, and the interest rate is 4.5 percent. Your monthly payment (principal and interest) on a 30-year loan would be $1900.07.
If the lender gives you a home equity loan of $168,750 ($375,000 * .85 – $150,000) with a 10-year term and 3 percent interest rate, your monthly payment would be $1,629.
Consequently, you’d save $271.70 per month and eliminate 10 years of interest payments at the higher rate.
Pros and Cons of Using a Home Equity Loan to Pay Off Your Mortgage
- It’s easier to budget for the monthly payment as it stays the same over the life of the loan.
- The interest rates are more competitive than what you’ll find with many other loan products.
- There are no restrictions on how you can use the funds.
- Your home is at risk for foreclosure if you default on the payments.
- You’ll pay interest on all the loan proceeds, even if you don’t use the entire amount.
- Most lenders assess points and fees in addition to closing costs.
Unlock Your Home Equity
What Is a Home Equity Line of Credit (HELOC)
A HELOC also acts as a second mortgage and lets you access your home’s equity.
How Do HELOCs Work?
Most lenders allow you to borrow up to 85 percent of your home’s equity, minus the outstanding mortgage balance. So, if your home is worth $435,000 and you owe $165,000 on the mortgage, you could qualify for a HELOC up to $204,750 ($435,000 * .85 – $165,000).
But instead of receiving the loan proceeds in a lump sum, you’ll get access to a line of credit. You can make withdrawals from this pool of cash at any time during the draw period, which is typically ten years. The lender will likely assess interest-only payments during the draw period as well.
When the draw period ends, the lender will convert the outstanding balance to a loan repayable in monthly installments (principal and interest) over an extended repayment period. Be mindful that the payment amounts fluctuate over time as the interest rate is typically variable with HELOCs.
How to Use a HELOC to Pay Off Your Mortgage
You can pay the balance in full at once or spread it out over the draw period. Suppose you pay the balance in full once you’re approved for a HELOC. In that case, you’ll only pay interest during the draw period, which could free up a load of space in your budget to meet more pressing financial goals. But if you can make extra payments towards the principal, you could curb the amount of interest even more.
It’s also possible to allocate funds from the HELOC to cover your monthly mortgage payment and give your budget breathing room. This approach likely won’t save you much unless the interest rate on the HELOC is drastically lower. You also want to ensure the term remaining on your mortgage is equivalent to the draw period. Even still, you’ll be stuck with the balance on your HELOC when the draw period ends.
Pros and Cons of Using a HELOC to Pay Off Your Mortgage
- You’ll only pay interest on the amount you borrow.
- The interest rates are generally lower than what you’d get with a personal loan.
- You’re not obligated to borrow the total amount you’re eligible for.
- You can use the funds however you see fit.
- The monthly payments could change over time with the variable interest rate.
- You can’t buy points to lower the interest rate.
- You could lose your home if you default on the payments.
Access Home Equity Without a Loan
Both home equity loans and HELOCs can be used to pay off your mortgage, but you’ll be forced to take on even more debt to leverage these tools. Or you can get a home equity agreement and tap into your equity without borrowing more money.
What is a Home Equity Agreement?
A home equity agreement is a debt-free option you can use to convert your home’s equity into cash. It’s an arrangement between a homeowner and investor that gets you money today in exchange for a share of the future profits in your home.
You won’t have to refinance your home. Even better, you’ll have 10 years to decide if you want to sell your home or buy out the agreement.
How Do Home Equity Agreements Work?
Below is a breakdown of home equity agreements work:
- Step 1: The homeowner is offered a lump sum payment or co-investment in exchange for a percentage of the future increase in value.
- Step 2: The home is appraised to ensure the offer is viable.
- Step 3: The homeowner reviews the closing documents and signs on the dotted line.
- Step 4: The homeowner receives the cash for the co-investment.
At the end of the agreement, the homeowner either sells the property or buys out the contract. Either way, the investor receives their initial co-investment plus their share of the profits. (Some investors also share in the losses, assuming you don’t sell the home before an agreed-upon date as specified in the contract).
What Can You Use the Cash from a Home Equity Agreement for?
You’re free to use the cash from a home equity agreement however you want. Consider using a portion to pay off your mortgage – the remainder can eliminate high-interest debt, beef up your nest egg, fund a big-ticket purchase or cover business expenses for your startup. The choice is yours.
How to Get Started with a Home Equity Agreement
If you’d like to explore a home equity agreement to possibly pay off your mortgage, consider the team of real estate financial professionals at Unlock to lend a helping hand. All you need is a FICO score of at least 500 and 80 percent equity in your home to potentially qualify for a co-investment between $30,000 and $500,000. Plus, you’ll get 10 years to decide if you want to sell your home or buy out the contract.
Unlock is accredited by the Better Business Bureau, so you can have peace of mind knowing you’re dealing with a reputable investment platform. View your home equity agreement offer in just 60 seconds by completing the online form. If your home is eligible and you decide to move forward, you could have cash in your account in as little as 30 days.