There is usually no larger investment a person makes than buying a home. Given the expense of purchasing a house, most people opt to take out a mortgage and slowly build equity in their home.
Home equity represents the portion of your home that you own versus what you still owe on your mortgage. For example, if your home is worth $200,000, and you owe $100,000 on your mortgage, then you have $100,000 in equity.
Building equity is important because you can tap into it to pay for major expenses such a home remodel, credit card bills, or college tuition. The more equity you have, the more funds you can access when you need them.
The first way to build home equity is to pay off your mortgage. You can do this by increasing your down payment or making larger mortgage payments. If interest rates are low, you can refinance to try to shorten your loan term or secure a lower rate. Alternatively, you can remodel your home to increase its value or wait for its value to increase naturally over time.
Buying a home and building equity is wonderful, but how do you access that cash when you need it?
4 Main Ways to Tap Home Equity
Home equity loans
Also known as a second mortgage, a home equity loan is a loan secured by the equity that you’ve built in your home. When you take out a home equity loan you receive a lump sum payment that you agree to pay back in a certain period for a fixed interest rate.
You can usually apply for a home equity loan online or over the phone. During the application, you’ll need to answer questions about your property, income, and expenses. A loan officer will then work with you to negotiate the terms of your loan and schedule a property evaluation. Finally, an underwriter will review your financial information and collect any supporting documentation needed to verify the details of your loan before the funds are disbursed. On average, the entire process takes 2-6 weeks, but can vary based upon the size and complexity of the loan.
A home equity loan is a good option for people who want to pay off higher-interest debt and can afford the additional monthly payment. With access to a lump sum payment, a home equity loan is also suitable for home owners who want to make home improvements and need access to a large amount of cash
| Pros | Cons |
|---|---|
| Lower interest rates than personal loans or credit cards | High closing costs (2%-5% of the loan) |
| Flexibility in how you spend funds | Risk of foreclosure if you default on the loan |
| Fixed monthly payments | Higher interest rates than HELOCs or first mortgages |
Home equity lines of credit (HELOC)
A home equity line of credit (HELOC) is similar to a home equity loan, but instead of getting a lump sum, you can make numerous withdrawals up to your maximum equity balance during your draw period. Unlike a home equity loan, HELOCs have a variable rate, and you’ll be expected to make monthly payments during the draw period. At the end of the draw period, you must pay off your balance as well as any closing costs or fees.
The HELOC application process is similar to that for a home equity loan. First, you’ll apply for a HELOC online or over the phone. You’ll then need to verify your income, expenses, and property value. After you get approved for a loan, your lender will schedule an appraisal of your property and ask you to submit supporting documentation. If everything checks out, you’ll be able to close on your loan and start taking withdrawals from your HELOC. On average, it takes around 4 weeks to complete and close on a HELOC application.
HELOCs are best used for long-term, recurring expenses such as college tuition, paying off medical debt, or completing home renovations. That said, you’ll typically want to avoid taking out a HELOC if you can get a lower rate elsewhere.
| Pros | Cons |
|---|---|
| Interest may be tax-deductible | Variable interest rates could mean higher payments |
| Withdraw funds as needed | Risk of foreclosure if you deafult on your loan |
| Interest-only payment options | Limited draw period window |
Cash-out Refinance
Cash-out refinance involves refinancing your existing mortgage by taking out a second, larger mortgage. You get to keep the difference in cash, which you can then use to pay bills or invest elsewhere.
The first step of the cash-out process is to apply with a refinance lender. Upon verifying your income, debt, and property valuation, a loan officer will review your application. If you’re approved, you’ll need to complete a property appraisal before you close on your cash-out refinance. From start to finish, the process usually takes 30-45 days.
Cash-out refinance is generally a good option if you need to complete home improvement projects, pay off high-interest debt, or cover large expenses such as college tuition. Alternatively, some people opt to use a cash-out refinance to reinvest these funds or purchase an additional property.
| Pros | Cons |
|---|---|
| Lower your interest rate | May need to pay private mortgage insurance (PMI) |
| Interest may be tax-deductible | Risk of foreclosure if you default on your loan |
| Flexibility in how you use the funds | Raise your debt threshold |
Co-investment
Also known as shared appreciation, co-investment refers to an agreement that lets you take out equity in your home in exchange for giving an investment company a financial stake in your property. The investor then gets to share in the rise of the property’s value, which is paid out at the end of the loan term in addition to the repayment of the equity advance.
To apply for a co-investment, you’ll need to find a shared appreciation company willing to take over a stake in your property. Once you verify your income, expenses, and property details, the company will agree to pay you a sum of money equal to a portion of the equity in your home.
Co-investment is usually a good option for people with a lot of equity in their home but poor credit and little cash. These people are usually not able to qualify for a home equity loan or HELOC, and can take advantage of co-investment to pay off higher-interest debt or other expenses.
| Pros | Cons |
|---|---|
| Lower qualification requirements compared to home equity loans or HELOCs | Lower equity limits compared to home equity loans or HELOCs |
| If your home loses value or doesn't appreciate, you may not have to repay your loan | Smaller homes and luxury properties may not qualify |
| Low monthly payments | Obligated to share apprecaition in home value |
Which of these ways to tap home equity is right for you?
Whether you want to remodel your home, consolidate your debt, or pay for a major life event like college or a wedding, a home equity loan may be right for you. The type of home equity financing you choose will vary depending on how much equity you have, the value of your home, your credit score, and what you intend to do with your funds. Luckily, a loan officer can help you determine which option is right for you after reviewing your income, debt, and property value.