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Our home is our personal space to just be us. We get to host friends, have meals, hang out and rest our heads at night. So a home has a certain intrinsic value.
You also spent a ton of money to get your home, and that makes it a huge investment opportunity. Every time you make a payment, you gain equity in your home. Your equity grows even faster in an environment where home values are rising, as they are now.
That equity can be converted into cash to unlock the true investment potential of your home. It can be used to pay off home improvements, augment a college fund or give your retirement fund a boost. In this post, we’ll go over your options for making your equity work for you, including home equity loans, home equity lines of credit and cash-out refinances.
Home Equity Loans
Home equity loans can come with either fixed or adjustable rates. They come with slightly higher rates than home equity lines of credit (HELOCs), which we’ll talk about next.
These allow you to take advantage of the home equity you’ve currently built up by taking out a second mortgage against your existing home equity – the amount of your loan that’s currently paid off – in order to make home improvements, for example. There may be limits set by lenders or investors in the loan regarding how much of this existing equity you can take a loan against.
The upside to this is that you have the option to go with a fixed payment. That way, your payment never changes and you know what you’re getting.
There are downsides. With home equity loans, in addition to having higher rates than HELOCs, you’re going to pay a higher rate than you would if it were your first mortgage since home equity loans are a second mortgage.
The reasoning for this is that lenders assume that you’re going to make the payment on your primary mortgage first. The lender that made the home equity loan also gets a lien on your house, but the primary lender’s lien takes precedence. In exchange for the additional risk, the lender on the second mortgage will charge you more.
On the other hand, with a cash-out refinance, you’re utilizing your equity by taking cash out and getting a new primary mortgage. If you do this, you’ll get a lower rate than you would if all else were equal on a second mortgage or options like a home equity loan.
Additionally, home equity loans taken out to do things other than build, buy or improve your home don’t feature tax-deductible interest after the 2017 tax year.
Quicken Loans doesn’t offer home equity loans at this time.
Home Equity Lines of Credit (HELOCs)
HELOCs offer lower rates than their home equity loan counterparts, so that’s a mark in the pro column. Before looking at a HELOC, though, there are some things you should think about.
For starters, HELOCs come with adjustable rates. That means the rate stays fixed for a certain period of time and then adjusts up or down based on market conditions for the remainder of the loan term. If you’re looking for payment certainty, this may not be the option for you.
You should also be careful when looking at the terms of the loan. HELOCs have a draw period and a repayment period. When you take out a HELOC, you have the ability to draw on the accumulated home equity for a certain period of time. During this time, you only pay interest on the equity you use. Sometimes this is the only payment you make during the draw period as you may not be required to make any payments toward principal during this time.
After the timeframe for drawing on the HELOC is over, it’s time to pay it back. At this time, a couple things might happen, depending on the terms of the loan.
In the first option, let’s say you had a 20-year HELOC. After a 10-year draw period, you start making payments on both the principal and interest in order to have the full loan paid off by the end of the term. Of course, at that point, the payments will be higher.
The second option used in other HELOCs have balloon payments at the end of the full term. You make the interest payments every month until the end of the term. However, at the end of the term, the full principal is due as one big lump sum payment. If you can’t afford to make the full payment at that time, you have to try to make payments toward the principal as you go.
If it’s still not feasible to make the balloon payment at the end, your best hope is to try and qualify to refinance the debt, ideally into a traditional mortgage so you don’t find yourself in that position again.
Like home equity loans, many HELOCs aren’t tax-deductible after the 2017 tax year unless you use them toward projects around the house. If you have any doubts, always contact a tax advisor.
Additionally, although the initial rates may be lower than similar home equity loans, they’ll be higher than the rates you could get on a cash-out refinance because it’s still a second mortgage on top of your primary mortgage.
Quicken Loans doesn’t offer HELOCs at this time.
Every situation is different, so we always recommend talking to a financial advisor. In many cases, however, the best option for utilizing your home equity is going to be a cash-out refinance. It features all the benefits of the other two options but also has a couple of key advantages. But first, let’s go over some basics.
What’s a Cash-Out Refinance?
Like home equity loans and HELOCs, you utilize your existing home equity and convert it into cash in a cash-out refinance. The difference here is that you aren’t taking out a second mortgage. It’s your primary mortgage.
The advantage here is because you only have one mortgage against your house, the lender knows you’ll work really hard to always make that payment at the beginning of the month. After all, if you don’t, they can eventually take the house back.
Because there’s less risk for the lender, you’ll get a better rate than you would if it were a second mortgage.
How Does a Cash-Out Refinance Work?
With any of these loans, the more equity you have, the more you can take and convert to cash if you need it. With a cash-out refinance, it’s especially important to take this into consideration. Why?
When you take cash out of your primary mortgage, you have to leave a certain amount of equity in your home. The exact amount depends on the type of loan you’re using.
With a conventional loan, you need to leave 20% equity in your home. FHA loans allow you to leave just 15% equity, but you’ll have to pay mortgage insurance premiums, so it’s something to think about. Finally, if you’re an eligible active-duty service member, veteran or surviving spouse, you can actually take out a loan for up to 100% of the appraised value of your property. This gives you the opportunity to maximize the impact of a renovation college fund or retirement savings boost.
When Does Taking Cash Out Make Sense?
Taking cash out can serve a variety of purposes. We’ll go over just a few of them and then talk about the factors you have to consider when determining whether it’s right for you.
You can take cash out in order to do maintenance, remodel or build an addition to your home. If you do this, the interest is fully tax-deductible because you’re making improvements to your home.
You can also take cash out in order to consolidate debt. Credit card interest rates are always going to be much higher than the rate on your mortgage. By applying the proceeds to fully paying off existing credit card balances, you can save thousands in interest.
You could also use it to boost your retirement fund, give your child’s college fund an infusion of cash, or use it for just about anything else you want or need.
The key here is that you need to be sure that you have enough equity built up to accomplish your goals while at the same time leaving at least the minimum amount of equity mentioned above in your home. If you know that, taking cash out may make sense.
One thing to note is that if you take out cash in order to consolidate debt or for some purpose other than working on your home, the interest may not be fully tax-deductible. You can still the deduct the amount of interest you would be paying on your existing loan balance prior to taking cash out, subject to IRS limits. Again, be sure to check with a tax advisor.
If you’re unsure whether the math on a refinance makes sense for you, you can get an idea from our cash-out refinance calculator.
If taking cash out sounds like it might be in line with your goals, you can get a full refinance approval online with Rocket Mortgage® by Quicken Loans. Otherwise, one of our Home Loan Experts would be happy to take your call at (800) 785-4788. You can leave any questions for us in the comments below.
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