Unlocking Home Equity For Investment: A Smart Strategy

Home equity is the difference between a property's current market value and the amount owed on the mortgage. Homeowners can unlock cash by taking out a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. A home equity loan is a second mortgage for a fixed amount that is repaid over a set period. A HELOC is a second mortgage with a revolving balance, allowing borrowers to take only what they need. Cash-out refinancing involves refinancing an existing mortgage with a larger loan and pocketing the difference. These options can provide funds for home repairs, college tuition, debt consolidation, or other investments. However, it's important to consider the risks and financial implications, such as increased debt, potential loss of the home, and market fluctuations.

Home Equity Line of Credit (HELOC)

A Home Equity Line of Credit (HELOC) is a type of second mortgage that allows homeowners to borrow money against the equity they have in their home. A HELOC provides the most flexibility as it works like a credit card with a revolving balance. You can borrow only what you need, pay it off, and then borrow again. This means you can access cash periodically over a span of time.

To qualify for a HELOC, you need to have available equity in your home, meaning that the amount you owe on your home must be less than the value of your home. Lenders will typically allow you to borrow up to 80% to 85% of your available equity. Lenders will also look at your credit score and history, employment history, monthly income, and monthly debts.

HELOCs usually have a variable interest rate, which means the interest rate can change over time. However, some lenders offer the option to convert a portion of the outstanding variable-rate balance to a fixed rate, which can protect you from rising interest rates. HELOCs often have lower interest rates than some other common types of loans, and the interest may be tax-deductible.

A benefit of a HELOC is that it allows you to borrow over time, so you can keep your monthly payments lower and avoid unnecessary debt and interest payments. However, a HELOC can be expensive, as you may be required to pay an application fee, attorney fees, and other costs. Additionally, your home is used as collateral, so you could lose your home if you can't make timely payments.

Popular uses for HELOCs include home improvements, education, and consolidating high-interest credit card debt.

Home Equity Loan

A home equity loan is a type of second mortgage that allows you to borrow a lump sum of money against the equity in your home. This type of loan typically carries a fixed interest rate and is repaid in regular monthly instalments over a fixed period, which can be as long as 30 years.

To qualify for a home equity loan, you will typically need a good credit score, a low debt-to-income (DTI) ratio, and a certain level of equity in your home. Lenders will usually allow you to borrow up to 80% of the equity in your home, although some may go up to 90%.

The application process for a home equity loan is straightforward, and can often be done online. The time it takes to process your application will vary, but if approved, you can typically access your funds within three business days after closing, with no closing costs.

It's important to remember that with a home equity loan, you are putting your home up as collateral. This means that if you are unable to make the loan repayments, the lender can foreclose on your home.

Cash-out refinancing

You can calculate the maximum loan you can take out by multiplying your home's value by 80% – this is generally the maximum Loan-to-Value (LTV) ratio that lenders will allow. Subtract your current mortgage balance from this amount. The difference between the balance on your previous mortgage and your new, larger mortgage is the amount you will receive in cash.

Requirements

To get a cash-out refinance, you'll need to meet the lender's requirements, which can vary. Typically, you'll need a debt-to-income ratio of 45% or less, a credit score of 620 or above, and at least 20% equity in your home.

Pros and cons

A cash-out refinance can be a good idea if you're able to get a good interest rate on the new loan. It can give you access to a large amount of cash at a relatively low-interest rate compared to personal loans or credit cards. It can also be helpful for debt consolidation, as paying off high-interest credit cards with the money from a cash-out refinance could save you thousands in interest.

However, since you're using your home as collateral, you risk losing it if you can't make the payments. You'll also be taking on a larger mortgage with a new set of terms, and you'll have to pay closing costs, which can be substantial.

Reverse mortgage

A reverse mortgage is a way for older homeowners to borrow money based on the equity in their home. If you're 62 or older, you might qualify for a reverse mortgage. The amount of money you can borrow is based on how much equity you have in your home.

There are three types of reverse mortgages:

• Home Equity Conversion Mortgage (HECM): These are the most common type of reverse mortgage and are federally insured by the Federal Housing Administration (FHA). HECMs are non-recourse loans, which means you'll never owe more than your home is worth. You can use the money you receive from a HECM for any purpose and choose to receive it as a lump sum, monthly instalments, or a line of credit.
• Single-Purpose Reverse Mortgage: These loans come with conditions from the lender to use the funds solely for an approved reason, such as home repairs or tax payments. They are generally less expensive than HECMs and are offered by some state and local government agencies or nonprofits.
• Proprietary (Private) Reverse Mortgage: These are offered by private lenders and may have higher interest rates. They are usually for high-value homes that exceed the conforming limit.

Pros

• No monthly payments: You only have to repay the loan when you sell the home, change your primary residence, or pass away.
• You can stay in your home: A reverse mortgage pays off your existing mortgage balance and allows you to continue living in your house.
• No income requirements: You can qualify for a reverse mortgage even if you're struggling financially.
• The money is tax-free: You don't have to claim the money you receive from a reverse mortgage as income on your tax return.
• You can target significant life expenses: With a HECM, you can use the funds for crucial items such as home repairs, living expenses, credit card debt, or medical bills.
• Your heirs won't be left in a bind: If you pass away, your heirs have several options, including giving the title to the mortgage lender with no additional costs, selling the home to cover the balance, or refinancing the reverse mortgage and starting to make monthly payments.

Cons

• Your loan balance will increase: If you don't make interest payments, your loan balance will increase over time and could snowball into a balance higher than your home's value.
• Additional fees: You'll have to pay origination fees, closing costs, and insurance costs, which will reduce the amount of money you receive from the loan.
• Limited tax deductions: Generally, you can't deduct mortgage interest on your tax return with a reverse mortgage.
• Impact on Medicaid and Supplemental Security Income: A reverse mortgage could affect your eligibility for these benefits, so it's important to speak with a financial advisor before applying.
• Risk of foreclosure: If you don't pay property taxes, HOA fees, homeowners insurance, or fail to maintain your home, you could lose your home through foreclosure.
• Loss of primary residence status: If you have to move into an assisted living facility, your home may no longer be considered your primary residence, which could affect your loan.

Remember, a reverse mortgage can be a complex and risky financial decision, so it's important to carefully consider all your options and consult with a financial professional or housing counselor before proceeding.

Home Equity Investment (HEI)

HEI is a good option for those with lower credit scores or a low or fixed income who want to avoid pricey monthly payments. There are no income requirements, and you don't need a perfect credit score. However, you will need at least 30% equity in your home, or a loan-to-value (LTV) ratio no higher than 70%.

HEI is not available everywhere, so check if it's available in your state. There will also be closing costs and fees to pay.

Frequently asked questions