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How to get equity out of your home? Here are the four most popular ways:
- Cash-out refinance
- FHA 203(k) refinance for home improvements
- Home equity loan
- Home equity line of credit
Any of those could be perfect — or damaging. Read on to discover which suits you best.
What is equity?
Equity is simply the amount by which the current market value of your home exceeds your mortgage balance today. If your property value is $200,000 and you owe $100,000, the difference between its worth and its value equals your home equity.
Your loan-to-value (LTV) ratio would be, in that case, 50 percent. because the $100,000 loan divided by the $200,000 value equals .5, or 50 percent.
If your mortgage balance exceeds the property value, as occurred in many places during the Great Recession, you are said to be “underwater” or have “negative equity.” Fortunately, that’s not eh case for most of us.
How much can you borrow?
While working out how to get equity out of your home, you need also to consider how much. Few lenders will allow you to access all of your home equity. Only the VA allows 100 percent cash-out refinancing.
For cash-out refinancing, most private lender guidelines (Fannie Mae, for example), max you out at 80 percent. FHA gives you up to 85 percent of your property value.
Most home equity loans go a little higher — to 90 percent if your credit history is excellent, and if your income supports the higher payments.
When you add a so-called “second mortgage” to your current mortgage, your loan-to-value is often called CLTV, for Combined Loan to Value.
How to get equity out of your home: cash-out refinance
With a cash-out refinance, you get a whole new first mortgage. That new mortgage pays off your existing one and you get a check for the balance, less whatever equity you or your lender decide must remain in the home.
Cash-out refinances rarely make good financial sense unless you get a better rate than the one you’re currently paying. And that’s unlikely at the time of writing because of recent rises in mortgage rates. It’s made even less likely because of risk-based lending (a.k.a. “loan-level pricing adjustments), which typically imposes a slightly higher rate on cash-out refinances than other ones.
However, there are times when you absolutely need cash. You might need to consolidate out-of-control debts or pay for something essential, such as medical bills. In those circumstances, the extra costs may be worth it.
Cash-out refinancing pros
Even with risk-based lending, this may well turn out to be the lowest rate you can find. It’s also likely to come with the lowest monthly payments, simply because you’re typically spreading those over the next 30 years.
Cash-out refinancing is one of the most popular, if not the most popular, for financing home improvements.
Cash-out refinancing, if you can better terms than you have on your current loan, can make sense, especially if the amount you are borrowing is large and the balance of your current mortgage is small.
So there’s a good chance a cash-out refinance will be the kindest to your household budget.
Cash-out refinancing cons
There are three main drawbacks:
- You’ll face high set-up costs, which make borrowing small sums of money expensive. That’s because the extra charges for a cash-out apply to the entire loan, not just the extra cash
- You’re resetting the clock on your mortgage. Instead of paying for your home in…