Perhaps you'd like to remodel your home, fund your child's education, or buy a new car. Or maybe you need money to consolidate your debts, recover from a financial setback or respond to a family emergency. A home loan can offer ready cash for all of these as well as a myriad of other purposes.What is equity?
The source of this cash is called "equity," which is the current value of your home minus however much you currently owe on any existing mortgages or other home loans.
For example, if your home is worth $300,000 and you owe $280,000 on your mortgage, your equity is $20,000. Or if your home is worth the same $300,000, but you owe $250,000 on your mortgage, your equity is $50,000. Essentially, equity equals appraised value minus debt.
If the amount you owe on your home is more than the value of your home, this calculation would result in a negative number and your equity would be zero, a situation sometimes referred to as being "upside-down" on your home loan.
Most homeowners need positive equity to borrow against their home. Those who have an exceptionally high credit score may be able to borrow up to 125 percent of the home's value, meaning that they would owe more than their home was worth.
Refinance to access your home equity
One way to turn the equity in your home into ready funds is to refinance your first mortgage for a larger amount and take the difference in cash. This option is called cash-out refinancing.
For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you might want to get a new mortgage for $270,000. Of that amount, $200,000 would be used to pay off your original mortgage and $70,000 would be yours to use for other purposes. In this example, you would still have $30,000 of equity in your home.
A new first mortgage usually makes sense only if the interest rate on the new mortgage would be significantly lower than the rate on your current mortgage. Essentially it allows you to "cash-out" a specific sum that you'll repay over the term of your new mortgage (usually 15 or 30 years).
Line of credit offers flexibility
Two other ways to tap equity are a home equity loan or a home equity line of credit. A home equity loan involves a specific sum of money and a set repayment schedule while a line of credit works a lot like a credit card but the money is secured by your home.
A home equity loan can be appropriate if you want to borrow a specific sum, say, $10,000 or $25,000, immediately and you want to make regular monthly payments over a set period of time such as 10 or 15 years.
A home equity line of credit is a good option if you don't know how much you want to borrow, don't need the money right away or want to repay any money that you borrow within a short time. Some homeowners set up a home equity line of credit just in case of a future financial need.
A refinanced first mortgage typically will have a lower interest rate than a home equity loan or line of credit, but refinancing usually has significantly higher up-front costs. If you are planning to access your home equity, it’s a good idea to compare the interest rates, costs, and monthly payments before you make a decision on which type of loan is right for you.
You may also find it helpful to read a comparison on Cash-out refinancing vs. home equity loan to help understand which is better.