You’ve probably heard of the four most common ways to get equity out of your home: selling the house, a home equity loan, a home equity line of credit and a cash-out refinance. But there are three alternative ways I’ve found to access that home equity.
The first is a traditional secured loan where you use your home equity as collateral for a personal or business loan. The second is called a shared appreciation agreement, where you essentially sell a part of your home to an investor. And the third is often called a reverse mortgage, and applies to those in or near retirement age.
Today, I want to cover all seven ways I’ve found to access your home equity. So let’s get started.
Before we start I just want to briefly define home equity so we’re all on the same page. Home equity is the difference between your home’s current value and the amount on your mortgage loan.
Let’s say you bought your home for $100,000 and took out a $80,000 mortgage. At that time you had $20,000 in home equity ($100,000 – $80,000)
Then let’s say 10 years later your home is now valued at $150,000 and your home mortgage balance is down to $50,000. Now you have $100,000 in home equity ($150,000 – $50,000).
That home equity represents part of your personal net worth, and we’ll see seven ways you can cash in on it.
Four Common Ways to Access Home Equity
For the sake of thoroughness, here are the commonly cited ways to access equity in your home. You may know about these already, so feel free to skip down the article.
Sell your home
The most common way people access their home equity is through selling. When you sell your home someone will likely pay you close to your home’s market value, and you use this money to pay off your mortgage. After you pay off your mortgage you’ll have your home equity left over.
There are a few things to consider when selling your home that affect your bottom line.
First is that if you use someone like a realtor to help you sell the home, you’ll be paying them a commission, which eats into the amount you take home. My realtor charges 3% on the sale, and there are typically two realtors involved in a home sale, So you generally pay around 6% of the sales price in realtor commissions.
Second, is that (at least in the U.S) you get to take home a large portion of your capital gains tax free. As of 2020, the IRS allows $250,000 in capital gains (and $500,000 for married filers) on the sale of a primary residence to be taken tax free.
Now selling your home is obviously a huge life choice. If you’re totally happy where you live and don’t want to sell, there are some traditional options offered by banks that allow you to access your home equity.
Home equity loan
The first of these is a home equity loan, which is also referred to as a second mortgage.
When you get a home equity loan, you actually take on a brand new loan in addition to your mortgage. This new loan behaves just like the other loans you’re familiar with. You’ll have a monthly payment, an interest rate, and a length of time the payments will last.
Banks will often lend you up to 85% of your home equity. So if you have a $150,000 home and a $50,000 mortgage, you can often get approved for a $77,500 home equity loan ($150,000 x 0.85 – $50,000).
When this happens you would have one loan of $50,000 (your original mortgage) and a second loan for $77,500 (your home equity loan). Two separate balances and two separate payments.
I also want to mention that the money you get from a home equity loan is tax free, PLUS you get to claim a tax deduction on all the interest you pay on your home equity loan.
Home equity line of credit
A home equity line of credit is similar to a home equity loan in that a bank will give you access to your home equity (also usually up to 85%).
The difference is that the home equity loan gives you one payout and has set terms for the payback of that amount. But the home equity line of credit doesn’t give you a payout until you request/access an amount. It’s literally a line of credit (with way better terms than a credit card).
Let’s say you’ve decided to take on a renovation of your kitchen all by yourself. You don’t want to buy all the supplies at once, and you don’t even know exactly how much you’ll spend. So you go for a home equity line of credit.
You go buy a bunch of flooring and access $1,000 from your line of credit. Now your line of credit has a balance and you’ll have minimum monthly payments, just like a credit card. Then you decide to buy a new refrigerator and request $2,000 from your line of credit. Your balance goes up and so do your minimum monthly payments.
Note: Home equity lines of credit often have a “draw” period where you may make interest only payments or may not have to make any payment at all.
If you don’t know how much money you need from your home equity, or you’ll be taking the money out at different times, a line of credit is probably the better option.
The last common way to access home equity is through a cash-out refinance. When we took out a home equity loan we were adding a second loan to our mortgage. But with a cash out refinance we pay off our mortgage and start with a new, bigger loan.
Here’s an example.
Let’s go back to the example of a $150,000 home with a $50,000 mortgage balance. Usually, banks will approve a refinance up to 80% of the current value of the home. In this case, 80% of the home’s value is $120,000.
So if we did a cash out refinance, we could take out a new $120,000 loan, then use $50,000 of that money to pay off our original mortgage. This would leave us with $70,000 in cash to use however we want.
And keep in mind that this $70,000 is tax free. And just like the home equity loan, we can deduct the interest paid on this new loan from our taxable income.
Alternative Ways to Access Home Equity
OK, I’ve reviewed the common ways to access equity in your home, but every technique has inconveniences. With the home equity loan and the cash out refinance you had to deal with monthly payments. Selling your home means you have to find a new one. And the home equity line of credit can be a hassle. The trick is to find the method with inconveniences that don’t matter much to you.
Here are three more ways to cash out on your home that have different advantages and disadvantages.
You don’t have to get a special type of loan to leverage your home’s equity. You can get approved for a personal loan or a business loan based on your credit score and debt to income ratio.
But what if you don’t qualify based on those factors?
If you have home equity, then you can use that home equity as collateral for another type of loan. The thing is, the only real reason to opt for a personal or business loan as opposed to a home equity loan would be differences in terms.
Personal loans usually have shorter terms, like 3-5 years. This also means that they can have lower interest rates.
And business loans have longer terms, sometimes up to 25 or 30 years. But they also more commonly have adjustable rates and higher interest rates.
If a home equity loan isn’t providing the loan terms you want, perhaps a secured loan will better fit your needs.
Shared appreciation agreement
A shared appreciation agreement is when you allow an investor to purchase partial ownership of your home.
The huge benefit of this is that you can get money without taking on a new loan payment.
There are two downsides. One is that you’re losing some of the wealth building power your home ownership provides. The second is that these agreements usually come with a due date. When you reach this date you’ll have to pay back the original amount you were given plus an amount based on the home’s appreciation.
It’s easy to qualify for a shared appreciation agreement. So most typically only partake in one if they can’t qualify for a traditional loan.
But every financing option has a place in a good investor’s tool belt. Cash flow outweighs just about any other consideration in my investing decisions. So any financing option that comes without a monthly payment is worth considering in my book.
If you are close to retirement age, then a reverse mortgage could be another way to access home equity without the burden of monthly payments.
With a reverse mortgage, you can get cash from your home equity as a lump sum, regular payments or as a line of credit.
Like the shared appreciation agreement, it is easy to qualify for a reverse mortgage. And when it’s easy to qualify, it’s also easier to get taken advantage of.
A reverse mortgage doesn’t get you out of paying for maintenance, insurance or property taxes.
A portion of your home equity will also go towards paying for the fees of closing on the agreement. And you may not be able to pass your home on to your heirs if too much of your equity gets sucked into the reverse mortgage.
Again, every financing option has its pros and cons. The only perfect financing is a gift, and you don’t get to decide when those come around.
If the traditional options of home equity loans and cash out refinances aren’t an option for you, then you may still be able to cash out your home equity with a secured loan, a shared appreciation agreement or a reverse mortgage.