It’s exciting to finally have no more monthly mortgage payments. You have no existing mortgage! But now that you have all that equity in your home, is it possible to get another mortgage to use for other purchases?
You bet you can. Lenders are happy to use the real estate equity you have built up in your home to give you a loan for other needs.Check your eligibility for a cash-out loan. Start here (Dec 9th, 2023)
Access home equity with a cash-out refinance
Taking out a new loan on your paid-off house is a big decision, and you really need to think about the ramifications. If you fall behind on repayment, you could risk foreclosure. Whether it’s the right choice will depend on your personal financial situation.
Any loan that isn’t considered a purchase is called a refinance — despite the fact that there isn’t a loan to pay off.Lana Jern, Owner of Uptown Mortgage
“Anytime you are taking money against your property, you are taking a debt that you didn’t have before,” Jern says. “How you will repay that loan is something to consider.”
She recommends that if you need a lump sum of cash, you consider another way to find the loan amount than borrowing against your primary residence. It’s possible that another type of loan — such as a personal loan — might offer lower interest rates.
For example, if you need to pay for your daughter’s college tuition and she needs a car, too, there might be several ways to find the funds instead of getting a new mortgage. Maybe your daughter can apply for a student loan through her college or the government, or you can acquire a low-interest car loan for the car she needs.
Before you decide to proceed with a cash-out refi or a second mortgage, consider how mortgage rates compare to the interest rates on other loan options. Though mortgage interest rates are often relatively low, it’s not always worth it to put your primary residence on the line — especially for non-essential expenses.
How to access home equity if you’ve paid off your mortgage
The process of borrowing against your home equity will be similar to the application process for your original mortgage when you purchased the home.
A lender will consider factors including your income, credit score, and debt-to-income ratio before issuing you a mortgage.
Conventional loans, HELOC & more: Refinance options
When you’re getting a cash-out refinance, you have a number of different home loan options to choose from. Different types of mortgages carry different loan terms, and different loan limits and some require monthly mortgage insurance.
The best option for converting your homeownership into cash will depend greatly on your personal finances.
Cash-out refinance: FHA vs conventional mortgages
If you’re sure a cash-out refinance loan is the right option, you can get a Freddie Mac or Fannie Mae mortgage refinance, or you can get one through the FHA loan program (which is backed by the Federal Housing Administration).
The amount of cash you can access will depend on your mortgage balance and your home’s market value.
With a cash-out refinance, borrowers can take out 80 percent of the home’s value in cash. This unaccessed amount of equity is functionally similar to the down payment made when home buying.
With an FHA cash-out refinance, the FHA loan limit is 85 percent of the value of your home. It will still be subject to FHA mortgage insurance which means you’ll have to pay a mortgage insurance premium (MIP) for the life of the loan and an upfront mortgage insurance premium. In addition to the cost of the insurance payments, an FHA cash-out refinance is also likely to carry a higher interest rate, especially for borrowers with lower credit scores.
For some people, taking out a cash-out refinance for an investment can be quite profitable.
“Let’s say you take out $100,000 cash from a refinance and invest it into creating more assets. If you put back more than what it cost you, then great,” she says.
For example, it could be worthwhile to use that cash for valuable home renovations or to make a down payment on an investment property.
For more information on the pros and cons of each, check out these articles:Check your eligibility for a cash-out loan. Start here (Dec 9th, 2023)
Alternatives to cash-out refinance: HELOC & reverse mortgages
A cash-out refinance isn’t the only way to turn your home equity into cash. It’s also worth talking to your mortgage lender about a home equity line of credit (HELOC) or a reverse mortgage.
If you need house repairs, Jern says, a home equity loan may work out better in the long run.
“If your home is paid off, you can apply for a home equity loan without much hassle,” she says. “However, a HELOC should be put in place before any emergency happens. It lasts 10 years, and you never ever have to take money out of it. But if you need it, it is there.”
Keep in mind though, if you haven’t set up a HELOC and your husband breaks his leg and can’t work, the lender won’t then give you the equity line of credit.
It doesn’t cost anything to set up a HELOC. This is a very inexpensive way to set up some security for the future. If you do a cash-out refinance, then you’ll have to pay closing costs. A HELOC is the cheapest money you’ll ever get.Lana Jern, Owner of Uptown Mortgage
Reverse mortgages can help older homeowners with things like medical expenses. The government doesn’t let you take more than 50 percent out in a refinance than the value of the property. The owners of the house can live in their home the rest of their lives with this sort of loan.
“Reverse mortgages can be an affordable option for older people that allows them to have the lifestyle they want like the ability to travel or take care of their house,” she says.
For more information about these other mortgage options, check out the full articles below:
A final note on cash-out refinances
When you get a new mortgage loan you’re taking on more risk. You put all the work into paying off the loan balance on your first mortgage so consider whether you want to re-introduce monthly payments into your budget. And, you’re going through the underwriting process with all the verifications and paperwork required that you did when you bought your home.
The government has put in some laws to protect consumers in situations like cash-out refinancing and HELOCs. Under the Truth in Lending Act, you have the right to rescind your HELOC or refinance loan within three days of closing.
“The government wants people to have time to go home and determine if they can really afford it,” Jern says.
For example, a cash-out refinance might make sense if you’re planning to make home improvements. You might use the money to pay off high-interest debt. This could be a good strategy if you want to do some debt consolidation and pay off credit cards — as long as you don’t accrue more credit card debt again going forward.
Bottom Line: Make sure that a cash-out refinance is the best financial choice for your situation — there may be other financing options available to accomplish your goals.See what cash-out refinance options you're eligible for here (Dec 9th, 2023)