3 ways to tap your home equity
You don’t have to sell your home to put your equity to work for you, of course. “There are three main ways to tap your home’s value while you’re still living there,” says Marie Imundo, director, Wealth Management Mortgage Strategy and Execution, Bank of America. They are a home equity line of credit (better known as a HELOC), a home equity loan (sometimes referred to as a HELOAN) and a cash-out refinance. “The best choice for you will depend on interest rates and what you need the money for.”
With a cash-out refinance, you get a new loan, ideally at a lower rate, to pay off your existing mortgage, plus some additional money from your home equity, which you might use to cover a home renovation project, or to help you manage any number of other current expenses. Cashing out your home equity is an option you might want to consider if you have a first mortgage on which you’re paying a higher interest rate than is currently available. “Keep in mind, though,” says Imundo, “that your new loan balance will be higher than your current loan, leaving you with a larger mortgage, typically a higher monthly payment (depending on available interest rates) and the potential to pay more interest over the life of the loan.”
“What if your current mortgage rate is already low? Then you may want to consider tapping into home equity through a home equity loan or a line of credit,” Imundo says. The difference between the two? Home equity loans are for a fixed amount and are often made at fixed rates of interest. Home equity lines of credit give you access to a set amount of credit, but you don’t have to use it all or all at the same time. You can tap that credit — and pay it off — as you need it during the “draw period,” or the term of the loan. Home equity lines of credit are often made at variable rates of interest, though you can find fixed-rate options.
A home equity loan may make the most sense for a fixed expense — say college tuition that you might want to pay off over a number of years — while generally a home equity line of credit is used for recurring items, like home renovations, which may require frequent and varied withdrawal amounts.
One thing you should never consider using your home equity for, notes Imundo, is investing. Stocks, bonds and mutual funds fluctuate in value, and you wouldn’t want to risk losing your home if the return on your investments is not sufficient to cover a new mortgage, loan or line of credit. If the value of your investments were to decrease, you might need to sell them to protect your home and limit further losses.
When the tuition bill comes due…
For some families, a HELOC can offer a way to finance a child’s annual college tab and could present a more attractive option than selling stocks, which may subject you to capital gains taxes. It could also mean reducing your stock holdings at a time when the market may be appreciating. Keep in mind, though, that a solution that’s appropriate for one family might not work as well for another.
The hidden benefits of downsizing
Many retirees decide to downsize in retirement, and doing so comes with potential added benefits — you can cut many home-related expenses. The Center for Retirement Research at Boston College found that empty-nesters were spending 30% of their income on property taxes, insurance, maintenance and utilities.3
The question for downsizers then becomes what to do with all of the unleashed capital. “There’s no single right answer,” says Imundo. “You and your advisor can look at all of the options to help figure out what might work best for what you want to achieve.” Then you can move on to focus again on the people and things that matter most to you ― and create new memories, perhaps in new places.