Taking equity out of your home can provide you with extra funds in certain situations, so it is important to know the best ways of doing it.
Looking for some magic money? Could you use a little financial help in repairing that leak in the bathroom or updating your 1970s-era kitchen? Taking equity out of your home might be just what the doctor ordered.
Of course, refinancing is not as simple as getting money whenever you want it. But there are ways you can structure a refinancing to get what you need. Understanding the strategies and how they work will help you know which to use.
The most significant factor in refinancing is the “why,” which will shape how you approach it. If you don’t take your particular circumstances into account, you’re putting yourself at risk for making a mistake that will cost you a lot of money.
Here are some of the most popular refinancing methods, how they work, and when to use them.
3 Approaches to taking equity out of your home
1. Taking equity out of your home with second mortgages
A second mortgage is very much what it sounds like. In addition to your original mortgage, you can take out a second mortgage against the portion of your home that you’ve already paid off. So, on a $300,000 home that you have $200,000 of equity in, you can take out a mortgage against that equity.
Be aware, though, that a second mortgage does not replace your first. You now have two separate mortgages to pay back. The second mortgage essentially uses the portion of your home that you own as collateral to get money.
This is a typical strategy to use for emergencies and large purchases, but use this with caution if you have a reduced income. Since you’ll be adding another mortgage, you will also increase your monthly expenses.
2. Taking equity out of your home with cash-out refinancing
Cash-out refinancing will only work under specific circumstances. If you don’t have enough equity in your home, for instance, it won’t work. With most lenders, you need to have 20% equity remaining in your home after the refinance.
For example, if you have a home valued at $250,000 and have $50,000 remaining to pay, that gives you $200,000 in equity. You can use a cash-out refinance. Your refinancing total, minus your remaining balance (and closing costs), would be what you could take as cash. So, if you refinanced for $150,000, you would take $100,000 (minus closing costs) as cash to use as you wish.
Taking equity out of your home with a cash-out refinance can be a great strategy if you plan to sell your home and need some extra money for repairs or updates to increase the value of the property before putting it on the market.
3. Taking equity out of your home with a line of credit
Taking equity out of your home with a line of credit is similar to using a second mortgage, except instead of cash, you receive a line of credit with variable rates and continuing access to funds.
This can be a useful strategy when you have an intermittent need for funds for whatever reason. The equity line of credit provides you with a draw period, during which you can use the funds, and a more extended repayment period where you must pay them back.
As a last word of warning, however, be careful with these strategies if you think you might have trouble paying them back. It can be damaging to your credit when you miss payments.
What do you think is the best refinancing strategy for you? What questions do you still have about refinancing?
Nancy Zambell, Chief Analyst of the Financial Freedom Federation, has spent more than 30 years helping investors navigate the minefields of the financial industry. Nancy's book, Make Money Buying & Selling Stocks is an introduction for new investors and a reminder for experienced investors on how to profit in the stock market.Learn More