In our previous article (link here) we showed the significant sums in the United States sitting in homeowners equity. As we discussed when looking at the size of capital we concluded it is such a powerful tool for homeowners who could be looking to tap into their homes and access some cash proceeds.
There are several methods in which you can extract equity from your home which are discussed below. Homeowners are increasingly looking at these methods to meet their financial needs or personal goals.
Home Equity Loan:
Commonly known as a second mortgage, a home equity loan allows you to borrow a lump sum of money using your home equity as collateral. The loan is typically repaid over a fixed term with a fixed interest rate. This option is suitable for homeowners who need a specific amount of money upfront. Usually this is repaid through a fixed monthly payment for a defined term.
Home Equity Line of Credit (HELOC) :
A HELOC is one of the most widespread ways used in by homeowners to tap into their equity. Simply it is a revolving line of credit that allows you to borrow against your home equity as needed. Similar to a credit card, you have a predetermined credit limit and can borrow and repay multiple times during the draw period, usually 5 to 10 years. The interest rates can be variable. A HELOC provides flexibility for homeowners who require ongoing access to funds.
With a cash-out refinance, you replace your existing mortgage with a new one that has a higher principal balance, allowing you to receive the difference in cash. This option is beneficial when mortgage interest rates are lower than your current rate. It enables you to access a substantial amount of home equity in a single transaction.
These three methods are most common forms used today. However there are some interesting and novel products emerging which allow different types of options for homeowners. One of these is known as a Home Equity Investment.
Home Equity Investment:
This is a relatively new concept where homeowners partner with investors who provide an upfront cash payment in exchange for a share of the future appreciation of the home. An even more novel product is to have the investor make your existing mortgage payment for you for a defined period of time. These options allows homeowners to access home equity without taking on additional debt or making monthly payments. There are usually no restrictions attached to this and the money is repaid predominantly through a home sale or a refinance of the existing mortgage. The investors here have more alignment with the homeowner sharing any increase or decrease in value.
Reverse mortgages are specifically designed for homeowners aged 62 and older. They allow you to convert a portion of your home equity into loan proceeds, which are typically received as monthly payments, a lump sum, or a line of credit. The loan is repaid when the homeowner sells the home, moves out, or passes away. Reverse mortgages can provide a source of income for retirees but come with specific eligibility criteria and potential risks. This product is more complicated and is subject to significant regulatory scrutiny and oversight.
And the simplest way of accessing equity in your property is to sell.
Sell and Downsize:
This is a different way to unlock your home equity by selling your current home and downsizing to a smaller, less expensive property. The difference between the sale proceeds and the purchase price of the new home can be used as cash or invested for other purposes. This approach allows you to access your home equity while potentially reducing ongoing expenses.
On all the examples above there are obviously pros and cons all dependent on the goals of the homeowner and their unique circumstances. Before deciding on any method to extract home equity, it's crucial to consider factors such as your financial goals, current interest rates, fees associated with the options, potential tax implications, and your long-term housing plans. Consulting with a financial advisor or a mortgage professional can help you evaluate the best approach based on your specific circumstances.
Our next article will look to explore the difference between a HELOC and a home equity investment and delve a little deeper into the perception of the pros and cons.