When is the best time to take equity out of your home?
Your kid is ready to go off to college. You need to replace your roof. Or maybe it’s time to pay off several high-interest credit cards. If you’re facing a major expense, you might be considering tapping into your home equity. After all, loans that use your home as collateral tend to have lower interest rates than unsecured personal loans, making them a more affordable option in some cases.
But how do you take equity out of your home, and when is the best time to do it?
Generally, it’s best to wait until you’ve built up a significant amount of equity, but a more exact answer will depend on your financial situation and stage of life.
Let’s take a closer look at several options, including home equity loans, HELOCs, cash-out refinancing, reverse mortgages and home sales.
Home equity loan
A home equity loan allows you to borrow against your equity, receive the funds as a lump sum, and repay them within a certain time frame. Home equity loans typically have fixed interest rates, which makes your monthly payments predictable.
You typically can’t borrow more than 85% of your total home equity, which is the value of your house minus any debts against it, including your mortgage.
You might consider a home equity loan if … you prefer steady payments each month, have a sizable amount of equity, and want to borrow a lump sum. You’ll have to pay closing costs and you could lose your house if you default on the loan, so it’s important to budget for the payments before taking out a home equity loan.
With a home equity line of credit, also called a HELOC, you can borrow multiple times against your equity during the draw period. Based on your finances, debt-to-income ratio and credit health, your lender will allow you to borrow up to an approved credit limit. After the draw period, you’ll need to pay the money back right away or within a certain time frame.
You might consider a HELOC if … you’re not sure exactly how much you’ll need to borrow or if you need to draw multiple times for various expenses. Because HELOC interest rates are usually variable, your monthly payments could change. You may also have to pay a set-up fee and annual fees, as well as withdrawal fees each time you borrow.
A cash-out refinance allows you to take equity out of your home by replacing your current mortgage with a new, bigger mortgage. You then receive the difference in cash.
You might consider a cash-out refi if … you can get a lower interest rate or more-favorable loan terms.
But unless you need to borrow a large sum, a cash-out refinance may cost more than it’s worth. After all, you’ll need to pay closing costs on the loan, and since you’re increasing your overall loan amount, your monthly payments and DTI could go up.
A reverse mortgage is another way to borrow money using your home as collateral. But instead of making monthly payments to your lender, your lender pays you each month, increasing the loan amount with each payment you receive.
You repay the loan plus interest and fees when you move out or sell the house. To qualify, you generally must be 62 or older, your home must be in good condition, and you need to have a significant amount of equity.
You might consider a reverse mortgage if … you need help paying for living expenses in retirement and want to keep your home. However, instead of inheriting your house, your beneficiaries would have to sell it after your death to satisfy the loan.
Selling your home
Selling your house may be a good way to take equity out of your home. The more equity you have, the more profit you can make, since you’ll likely need to use part of the proceeds to pay off your existing mortgage and any other debts against the property.
You might consider selling your home if … you’re already planning on moving. However, selling your house does come with expenses. Seller closing costs often include the real estate agent commission, around 6% of the home sale price. You may also have to pay for presale inspections, home repairs, cleaning, home staging and, in some cases, capital gains tax.
FAQs: Taking equity out of your home
You could borrow against your home equity if you need cash for very large expenses, such as major home repairs, college tuition or medical bills. Loans using home equity can often be more affordable than unsecured personal loans, thanks to lower interest rates. But they use your home as collateral, meaning your lender can repossess your house if you can’t repay the loan as agreed.
Yes, you can also take equity out of your home through a home equity loan, a HELOC, a reverse mortgage or by selling your house. The right choice for you will depend on your financial situation and stage of life.
The amount you can borrow depends on your lender, the loan type and your equity. For example, with a home equity loan or HELOC, the most you can borrow is usually up to 85% of your equity, while the limits for cash-out refinances is typically 80%.
Taking equity out of your home isn’t a decision to make lightly. Research your options thoroughly and see if there are more affordable or less risky ways to pay for major expenses.
If you decide to take out a loan, it’s a good idea to ask for quotes from various lenders to ensure you get the best deal possible. Look at lender reviews, too, and beware of fraudulent and unrealistic claims about the benefits of tapping into your home equity.