Home values have skyrocketed all across the US over the last 2-3 years. This has resulted in hundreds of thousands of dollars in additional equity for a large percentage of American homeowners. Tapping into that equity can be a great way to do things like:
– Pay off all other debts (credit cards, student loans, car payments, etc) so the mortgage payment(s) are the only monthly debt bill
– Pay for home improvements
– Get cash out to use for reserves/savings, or even for a long-needed vacation
– Take cash out for business or other investments
Here are the most common ways to tap into home equity when you have a lot of it:
Cash out refinances. A cash out refinance is a new, larger mortgage to replace your current mortgage. Basically, let’s say a borrower owes $200k on their home now and the value has jumped up to $400k. They could replace the current mortgage with a $300k mortgage and pocket the additional $100k (minus closing costs) after paying off the current $200k loan.
The main deterrent to cash out refinances right now is that rates have jumped significantly higher in 2022. A cash out refinance can make great sense if the mortgage interest rate stays in the same ballpark. But if it means a much higher rate, going with a HELOC or 2nd mortgage might make more sense. However, in cases where the credit isn’t strong, going with a cash out might be the only viable option.
HELOCs. A HELOC or home equity line of credit is just what it sounds like — it is a line of credit that borrows against the value of your home. In some ways, it is like a large, low interest rate credit card that uses your home as collateral. For instance, if someone were to get a $150k HELOC, that does not mean they have borrowed $150k. The $150k is the maximum they can borrow if they need it. Maybe they’ll only use $70k of that available line. And with a HELOC you normally only pay interest on what you’ve actually borrowed, as with a credit card. A HELOC is in 2nd lien position behind your first mortgage and the best rates are usually if the first mortgage and HELOC combined don’t exceed 90% of the home values. So as an example, if the home is worth $400k and the first mortgage is $200k, a $160k HELOC would put the two at 90% together.
Most HELOCs are interest-only adjustable rate loans. So as interest rates in the overall market change, the rate on the HELOC will change. This poses some risk to borrowers who could find their HELOC rate drifting higher over time. And the fact that HELOCs tend to be interest-only loans mean borrowers who only make the minimum payment don’t make any progress on paying the balance down. So managing a HELOC takes some discipline — again much like credit cards. HELOCs generally require good credit scores from the borrowers to make sense. Interest rates tend to be quite high for anyone with credit scores below 700.
Fixed rate 2nd mortgages A fixed rate second mortgage does not have the issue of rates adjusting with the markets. It is just like a first mortgage in most ways. Basically, a $100k 2nd mortgage would mean the borrower gets ~$100k in cash and pays the principal and interest payment on that 15-30 yr fixed loan every month in addition to paying their first mortgage. It is difficult to get a HELOC on an investment property so the fixed rate 2nd is a popular route for homeowners looking to take cash out of their rental properties.
All of these options can be very useful. Contact us in the sidebar today to learn more or to get an estimate.