Home Values Are Going Gangbusters. Here Are 3 Ways to Tap Into Your Equity
My husband and I recently reached a net worth of $100,000.
But that doesn’t mean I’ve got six figures sitting around.
U.S. home prices rose at a crazy-fast pace over the last year, and that means homeowners like me saw a big increase in home equity.
See, your home is an asset, and over time — hopefully — that asset gains value, and your home’s worth becomes greater than what you owe on the mortgage. The gap between the two is called equity.
Many people let that equity grow, and when it comes time to sell the house, they put the equity toward the next one. But some people would rather stay put and use their equity either toward home updates or other financial goals.
For those who aren’t looking to sell, there are several ways to access your home equity.
Home Equity Line of Credit vs. Home Equity Loan
The two most popular ways to access your home’s equity are a home equity line of credit (HELOC) and a home equity loan. They sound similar, but they’re distinctly unique — and the one that’s right for you could be based on what you’ll use it for.
But it’s important to note that neither of these options are better than saving for big expenses. When you wait to make home upgrades until you can afford to pay cash for them, you’re guaranteed to pay less than using a HELOC or home equity loan.
Home Equity Loan
With a home equity loan, also referred to as a second mortgage, the lender gives you your money all at once. You repay it at a fixed interest rate over a set period of time, referred to as a “term.”
Because a home equity loan is paid in a lump sum, you should be ready to start paying interest on the entire balance.
“Unless you’re using the loan to make repairs or improvements to your home, it is usually not a great idea,” said Randall Yates, CEO of The Lenders Network.
Investing that money back into your home will help increase its market value, but Yates cautions people against using it to repay debt.
“Using the funds to pay off unsecured credit card debt is risky, because if you face financial problems, your home is in jeopardy of being foreclosed on,” he said.
Ultimately, if you’re using your equity for a one-time expense or if you know exactly how much you’ll need to take out, a home equity loan could be a good option.
Home Equity Line of Credit (HELOC)
If you don’t know how much you need or how long you’ll need it for, a HELOC might be a better option. You’re given a limit to borrow, and you can take as little or as much as you need whenever you want.
“The advantages to it are you only pay on the money you borrow,” said Ralph DiBugnara, president of Home Qualified. “Think of it like having a low-interest credit card on your home.”
The downside: Interest rates for HELOCs are typically adjustable and are often higher than rates for a home equity loan.
Other Options: The Cash-Out Refinance and Reverse Mortgage
You can also access your equity by refinancing your first mortgage with a mortgage that’s slightly more money than your current one, and then pocketing the difference.
You can usually get lower interest rates and monthly payments, but because the cash is rolled into the term of your entire mortgage, in the long run you’ll pay more in interest over the life of the loan unless you pay off your home early.
Another option you may be familiar with (from its robust advertising budget) is a reverse mortgage.
The majority of reverse mortgages are actually home equity conversion mortgages, or HECMs. These are federally insured mortgages, similar to home equity loans. They allow homeowners 62 or older to tap into a portion of their equity and usually don’t need to be paid back while the person lives in their home.
Advertisements make a reverse mortgage look like a great option for seniors, but the reality is less sweet. Because homeowners aren’t required to make payments toward the loan, interest compiles, and the loan balance can balloon quickly.
This often makes them the most expensive way to access home equity.
Many people think a reverse mortgage will cover them until they die, but depending on the age of the homeowner and value of the home, someone can easily outlive their equity.
Jen Smith is a staff writer at The Penny Hoarder. She gives money-saving and debt-payoff tips on Instagram at @savingwithspunk.