Homeowners

Home Equity Loans Can Provide Much-Needed Cash: How to Choose the Right One for You

Today’s homeowners are sitting on near-record levels of home equity following years of rapidly rising prices. They collectively have more than $34 trillion in the U.S., according to research by Goldman Sachs.

If you have built up equity in your home and are hoping to tap into it, you have a lot of options. There are a variety of home equity loans. However, they are not a one-size-fits-all solution. The right loan will depend on your personal circumstances.

When used wisely, these financing solutions can boost cash flow, increase property value through strategic upgrades, or even help you avoid high interest credit card debt.

They may even lead to tax savings when you use them to substantially improve your home.

“Home equity loans can be used to cover home renovations, medical bills, a small business, or even college. You may also use them as an emergency fund in times of need,” said Hugh Steven Morris, president and senior wealth advisor at The Morris Group at LPL Financial in Raleigh, N.C.

The 4 most common home equity loans

There are many different types of home loans that may allow you to tap into your equity. Below are four of the most common types of home equity loans.

1. Home equity lines of credit (HELOCs)

An HELOC works like a line of credit. You can withdraw as much or as little as you’d like during the draw period, up to your set credit limit. The draw period generally lasts five to 10 years. You only pay back what you use, plus interest, over your repayment period, which typically runs 10 to 20 years.

The main drawback is that most HELOCs come with variable interest rates. That can lead to fluctuating, unpredictable payments.

However, if you’re looking for a flexible option that provides ongoing access to cash, it may be worth exploring.

2. Cash-out refinances

A cash-out refinance is another loan that allows homeowners to access their equity. It replaces your current mortgage with a new, larger one. You pocket the difference in cash and pay it back each month. You can put the cash toward virtually any expense.

If you have a high-interest mortgage and prefer a single payment at a lower rate, a cash-out refi may be a solid choice. These loans have lower interest rates than credit cards and many other types of loans.

The caveats are that you restart your mortgage clock with a new loan. If you secured a lower rate several years ago, you may be trading it for a higher one. So, you may wind up paying more in interest over the life of your loan.

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3. Second mortgages

A second mortgage is just like it sounds, a second home loan. Homeowners may be able to leverage their equity for these loans, which provide a lump sum of cash. But unlike a cash-out refinance, you’re not replacing your current mortgage. This is a loan that’s made in addition to your existing loan.

Second mortgages may come in handy if you need to cover a one-time expense, like a major renovation or medical bills, but you want to keep your original mortgage intact with the same mortgage interest rate and payment terms. This allows those who locked in low rates during the pandemic to keep those rates.

One of the downsides is that you will have two monthly payments to manage instead of one. Plus, you’ll owe closing costs and might have to settle for a higher rate than what you’re paying on your primary mortgage.

4. Reverse mortgages

If you’re 62 or older, a reverse mortgage may allow you to turn your home equity into income. Homeowners receive monthly payments, ultimately increasing their cash flow. The loan doesn’t need to be repaid unless the owner sells the home, moves, or passes away.

While a reverse mortgage may be a smart move if you qualify for it, keep in mind that it will decrease the equity in your home over time. In addition, you may face high fees and reduce the inheritance you pass down to your loved ones.

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Tips for homeowners considering a home equity loan

Before you go ahead and move forward with a home equity loan, it’s important to consider a few things first.

1. Understand your goals: Focus on what you hope to accomplish with your home equity. This can help you make the most out of the equity you’ve built.
2. Ensure your income is stable: Since missed home equity loan payments may result in foreclosure, make sure you have the ability to repay the loan. Don’t borrow more than you can comfortably repay.
3. Shop around for the right loan: Do your research. Compare interest rates, repayment terms, and how each option affects your mortgage repayment timeline.
4. Think long-term: Home equity loans aren’t for everyday expenses.

“Your home equity is either your largest or second largest wealth building tool,” said Morris. “So, it is important to make sure you use it in a way that’s going to support your long-term goals.”