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You finally own your home free and clear and want to put that equity to use — without having to sell. Is this even possible?
Fortunately, the answer is yes. If you qualify, you could obtain a home equity loan on a paid-off house, or a home equity line of credit (HELOC) or reverse mortgage — or, you might opt for a cash-out refinance or shared equity investment. Each has its pluses and minuses.
You can take equity out of your home even after your mortgage is paid off. One of the easier ways to do this is to sell your home, but there are also financial products that allow you to extract equity from your paid-off home quickly without having to pick up and move.
“It is definitely possible to take equity out of your home after you’ve paid off a previous mortgage,” says Jeffrey Brown, branch manager with Axia Home Loans in Bellevue, Washington. “Assuming you qualify, you can access that equity at any time.”
Why would anyone pursue fresh financing after finally paying off a mortgage? There are many viable reasons, from funding a home improvement project or investing in a business to purchasing more property. Two good rules to follow: Use your equity for long-term projects that create more value than the cost of the loan, and don’t take out more than you can afford to lose.
“Many seek to pay for their children’s educational expenses, fund their retirement or pay for an unexpected medical emergency like cancer care for a loved one,” says Kelly McCann, an attorney specializing in construction and real estate with Burnside Law Group in Portland, Oregon.
There are also not-so-good reasons to draw from your equity, such as buying a car (a depreciating asset), paying for a wedding or taking a vacation. It’s important to get clear on your goals so you’re making a sound financial decision.
Let’s say you were still paying off your mortgage, had adequate equity and needed cash. You’d likely do a cash-out refinance, which typically has a relatively lower interest rate compared to other types of loans.
You can do the same now, even though you’ve paid off your mortgage. You’ll simply take out a new mortgage and pocket equity in the form of cash at closing. Like any refinance, however, you’ll be on the hook for closing costs, which can run 2 percent to 5 percent of the amount you’re borrowing and any escrow payments.
“A cash-out refinance generally results in the lowest interest rate and offers the highest loan amounts you can borrow,” says Matt Hackett, operations manager for Equity Now, a mortgage lender headquartered in Mamaroneck, New York. “It can be a fixed- or adjustable-rate loan, and it is fairly straightforward to apply and qualify for.”
Alternatively, you could apply for a house-paid-off home equity loan.
Like a cash-out refinance, a home equity loan is secured by your property (the collateral for the loan) and enables you to extract a large amount of equity because you have no other debt attached to the residence. You’ll also likely need to pay closing costs, and as with any mortgage, you risk losing your home if you can’t pay it back.
The upsides: Home equity loans typically come with fixed interest rates, which are usually much lower than personal loan rates. Plus, if you qualify, you can deduct the mortgage interest on your taxes.
Many homeowners like the flexibility of a HELOC, which works more like a credit card you can use when you need it.
“HELOCs come with adjustable interest rates, often based on the prime rate,” says Hackett. “They offer the opportunity to draw funds and pay back funds during the initial draw period, which is more flexible than a standard first mortgage.”
What’s more, you’re only responsible for repaying the amount you use versus the fixed obligation of a cash-out refinance or home equity loan, says Vikram Gupta, executive vice president and head of home equity for PNC Bank.
“Additionally, HELOCs typically do not have closing costs, although they may have early closure fees,” says Gupta.
HELOCs aren’t as easily attainable, however, have smaller loan limits in general and are subject to increasing market rates.
If you’re age 62 or older, you might be considering a reverse mortgage. This financing vehicle gets you regular payments from a mortgage lender in exchange for your home’s equity.
“A reverse mortgage can be a great way for seniors to access the equity in their homes to pay for monthly living expenses and keep them living independently, especially if they don’t have monthly income in retirement,” says Brown.
Reverse mortgages have pros and cons, though. You’ll still need to keep up with homeowners insurance, property tax and HOA dues payments to avoid foreclosure, and there’s a limit to how much money you can get. You can’t let the home fall into disrepair either — you’ll still be responsible for maintenance.
“It’s important for the borrower’s survivors to understand that the entire balance, plus interest and fees, is due if the borrower passes away,” says Gupta. “The borrower’s house may need to be sold if their estate cannot repay the reverse mortgage loan.”
With a shared equity investment — a newer method of liquidating equity — you’ll sell a portion of your future home equity in exchange for a one-time cash payment.
“The details on how this works and what it costs will vary from investor to investor,” says Andrew Latham, CFP, CPFC, content director and managing editor for SuperMoney.com. “Let’s say you have a property worth $600,000 with $200,000 in equity built up. A home equity investor might offer you $100,000 for a 25 percent share in the appreciation of your home.”
If your home’s value increases to $1 million after 10 years — the typical term for a home equity investment — you’d have to return the $100,000 investment plus 25 percent of the appreciation, which in this case would be $100,000. You’d also need to return the investment plus the share of appreciation if you sell the home.
“The advantage here is that you can tap into your home’s equity without getting into debt,” says Latham, “and there are no monthly payments, which is a great plus for homeowners struggling with cash flow.”
In effect, you’ll have a silent partner in your home, so you’ll need to be comfortable with that and the rights that partner has to protect their investment.
There are rewards and risks involved with accessing equity when you own your home free and clear.
On the plus side, it can be relatively easy to qualify for home equity financing since you already have a solid track record of paying off your first mortgage, which likely means you’re older and have good credit and possibly a higher income. This ups your creditworthiness as a borrower, making you a preferred candidate to lenders and lowering the interest rate you’ll pay.
Furthermore, you can use your equity for any reason. Most lenders won’t care, for instance, if the money will be put toward funding retirement, seeding a new business or making a down payment on an investment property.
“Also, it may be smarter to tap into your equity than selling your home and downsizing,” says McCann. “If you have a capital gains on your home of more than $250,000 (or more than $500,000 if you are a married couple) you must pay taxes on that gain after the sale of your home. However, if you borrow against your home by, for example, taking out a home equity loan, you don’t have to pay taxes on the loan proceeds — you get the money tax-free.”
Of course, if you choose a form of financing wherein your home is used as collateral, like a cash-out refinance or home equity loan, there’s always the risk that you could lose your home if you can’t repay.
There are also upfront costs associated with many financing products, so you’ll have to come up with the funds to pay for expenses like lender fees and an appraisal, if required.
Whether or not you should pull the trigger on a new cash-out mortgage , home equity loan, HELOC, reverse mortgage or shared equity investment depends on your circumstances, short- and long-term financial goals and ability to repay the debt. If you were to lose some retirement income, say, would you still be able to make the payments?
“Homeowners should ask themselves: ‘What is the purpose of the funds needed?’ They also need to assess their individual financial situations to ensure they have the cash flow to pay off the loan in the future, particularly as they approach retirement,” says Gupta.
“Practice due diligence when shopping for a mortgage, like any financial product, and make sure they shop around with several lenders to find the best option and determine their best course of action,” says Hackett.
Bankrate.com is an independent, advertising-supported publisher and comparison service. Bankrate is compensated in exchange for featured placement of sponsored products and services, or your clicking on links posted on this website. This compensation may impact how, where and in what order products appear. Bankrate.com does not include all companies or all available products.
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