Residential home values have increased by 10-18% in 2021. This means that if your home was valued at $500,000 at the beginning of 2021, it is worth $50,000 to $90,000 more now. You may be thinking, that is amazing but I cannot realize that gain unless I sell my home, right? Not necessarily, you may be able to turn that home equity in to cash by refinancing your mortgage or by opening a home equity line of credit. I will explain the advantages and disadvantages of both options here.
You may have a need for cash to complete some home improvements, or to consolidate debt, or to start a new business, and converting your home equity to cash could be the most cost effective solution. Let’s look at the two main options (without selling your home):
Refinance your current mortgage: depending on your credit score, your income, and your home type, you should be able to borrower up 80% of your current home value. For example, if your home is worth $500,000, and you owe $300,000 on the mortgage, the maximum new loan would be $400,000. After subtracting the closing costs of the new loan, you would get around $95,000 in cash. These funds go in to your bank account after closing and can be used for any purpose. Why is this a good option? A. The most common mortgage product for a cash out refinance is a 30 year fixed loan, meaning the interest rate and payments are locked-in and will not change over time. B. The option for a 30 year re-payment period means the monthly payments will be low. C. The interest you pay on this type of loan is tax deductible. Cautions: you will pay around $2000-3000 in closing cost and with a new 30 year fixed loan, you will be starting the re-payment period of the loan over again.
Home Equity Line of Credit: like a refinance, depending on your credit score, your income, and your home equity, you should be able to borrow up to 90% of your current home value. For example, if your home is worth $500,000, and you owe $400,000 on the mortgage, the maximum new loan amount would be $50,000. After subtracting the closing costs, you would get around $48,000 in cash. Unlike a refinance, these funds are available on a line of credit that is accessible by drafting a check, using a credit card, or taking a draw (on-line or in person). Why is this a good option? A. If you do not need all of the available cash at one time, you can draw on the funds as you need them (while doing home improvements over an extended period of time, for example). B. The closing costs to open this type of loan are lower than a refinance. C. A full home appraisal may not be needed (saving time and money). Cautions: The interest rate is variable (it is tied to the Prime Lending rate), the monthly payments are interest only (meaning, if you make the minimum payment, they balance does not go down), and the interest you pay may not be tax deductible (funds must be used for home improvements and total mortgages on the home must be under $750,000).
In summary, converting equity in your home to cash can be done smartly and cost effectively if you know the rules and match the loan product to your situation and goals.