There’s about $25 trillion of home equity in the United States. That’s nearly half the value of the US stock market. But as you know, home equity isn’t nearly as liquid (accessible) as the stocks or mutual funds you hold. In general, that’s actually a good thing.
So, how can property owners tap into their accumulated equity? Oh, let me count the ways! Here are six, listed alphabetically:
· Cash Out Refinance
· Equity Share
· Home Equity Line of Credit (HELOC)
· Home Equity Loan
· Reverse Mortgage
· Sell
A brief description of each is below, with Pros and Cons.
But wait! There are disclaimers. They are usually tucked away at the end of messages, in fine print that no one reads. In this case, we’re putting them right up front.
None of the following constitutes property management advice or is an offer or recommendation to buy or sell any product or service. The descriptions below are offered in good faith, but are not guaranteed to be accurate, complete or exhaustive. Doing so would make this TL;DR (too long didn’t read). Household needs, circumstances, and solutions vary widely. Consult with reputable and trusted tax, legal, and financial advisors before proceeding.
👉 Cash Out Refinance
This is where an existing mortgage is replaced with a new, larger one that has a lower interest rate. The property owner pockets the difference between the old mortgage balance and the new one, less the transactional fees.
Begin the process by contacting your current lender to see what’s on offer. Use a mortgage refi calculator like this to get some rough estimates. These will give you a stake in the ground to make competitive comparisons. Then maybe shop at a place like Lending Tree.
Pros
There are no restrictions on how you use the money.
There are no tax consequences.
It can get you over a short-term cash demand like for higher education or doing a major home improvement.
Cons
You’ll need to show that you’ll be able to make the new payment. A good FICO score helps.
Interest rates on cash-outs are higher than for standard financing.
It’s likely you’ll end up paying more interest over the total life of the mortgage.
There are closing costs and fees. “No fees” usually result in higher payments.
A cash out refi reduces the equity you’ll realize when the property is eventually sold.
👉 Equity Share
Equity Sharing has become increasingly popular. This is where the homeowner gets cash in exchange for future equity gains. A $1,000,000 property might give you up to $800,000 of cash without selling. However, when the ultimate resale happens, the owner will get none of the increased value from the time the Equity Share was created.
Pros
Property owner gets cash.
Proceeds can be used for any purpose.
Property owner does not have to sell or move.
There are no tax consequences.
Cons
The homeowner surrenders all future equity accumulation.
Fees can be substantial.
👉 Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit is similar to a Cash Out Refinance, except the original mortgage is not replaced and a new one is created. In essence, it’s a second mortgage with a second set of mortgage payments. Owners usually set up a “credit line” and access it as needed.
Pros
The property owner has flexibility about when to access funds and by how much.
There are no restrictions on how the money is used.
The property owner does not have to sell or move.
There are no tax consequences.
Cons
Interest rates are usually higher than a cash out refi.
A second payment is created.
Adds to a property owner's fixed costs.
👉 Home Equity Loan
A Home Equity Loan is when a large lump sum is borrowed against the equity built up in a property. Lenders might allow borrowing up to 80% of the property equity if the borrower is in excellent financial condition. The loans usually have fixed interest rates and repayment periods are typically 5 to 30 years.
Pros
Property owner gets a lump sum.
There are no restrictions on how the money is used.
Property owner does not have to sell or move.
There are no tax consequences.
Cons
If there is one mortgage still active, this is essentially a second mortgage.
Defaulting on payments can lead to foreclosure.
Owner equity is diminished.
Fees can be substantial.
👉 Reverse Mortgage
A Reverse Mortgage uses the property equity to pay cash back to the property owner. Government rules do not require the homeowner to pay back the amount before any specific period. Nevertheless, you’re giving back a stake in your property to the lender in return for cash flow. Heirs to the property will need to pay the loan back if they want to keep it.
Pros
Produces a monthly income to the property owner.
The 2022 reverse mortgage maximum is $970,800.
Cons
Property owner must be at least age 62.
Property owner’s equity is reduced.
Heirs must pay back the proceeds if they keep the home.
👉 Sell
The most straight-forward of all the equity liberation options.
Pros
You have cash in your pocket. No strings attached.
You can easily rightsize or relocate.
Cons
You still need a place to live.
Transaction costs.
There may be capital gains taxes.
Added this on 4/7/22: https://www.advisorperspectives.com/articles/2022/03/21/how-to-safely-cash-in-on-your-home-equity-windfall
James Cosgrove, CFP, Plano, TX jim.cosgrove@verizon.net 972-489-0262
Jim Cosgrove, Partner, San Jose, CA jimcos42@gmail.com 408-674-6315 Twitter@JimCos542
Evidence-based. Rules-driven. Policy-focused.
