Understanding Home Equity Loans, HELOCs, Reverse Mortgages and Alternatives

Consider your HELOC and HELOC alternatives carefully

Liquidating home equity for cash can be an effective tool for consumers who need to pay for major life expenses, anticipated or otherwise. As the real estate market continues to grow, many homeowners find themselves with increasing equity in their property. In fact, 19% of homeowners have at least 50% equity in their homes, totaling more than $11 trillion in home equity wealth nationwide. Cash out refinances and HELOCs have been steadily increasing in the wake of historically low interest rates and American homeowners now have more ways to access their property wealth than ever before.

However, navigating all the options available to potential home-equity borrowers can be challenging. Whether you are looking to pay off an existing debt or you are planning ahead for an upcoming expense like college tuition or retirement, learning about all of your options is critical to successfully finding the best finance solution for you.

Cash-out Refinance

Refinancing your home to cash out some equity is an alternative option to home equity loans and HELOCs for homeowners who have paid off a significant amount of their mortgage or for those who have seen their home appreciate in value. With a cash-out refinance, you are essentially getting a new (and larger) mortgage on your existing home – you use some of the money from that mortgage to pay off your existing mortgage and you receive the cash for the extra amount. For example, if your home is appraised for $750,000 and you only have $400,000 remaining on the loan, you can generally cash out up to 80% — in this case, $200,000 (80% of $750,000 is $600,000 less the $400,000 mortgage balance leaves $200,000 in equity). Your new loan amount is $600,000, but you keep the extra funds without having a second mortgage. A benefit compared to home equity loans or HELOCs is that a refinance generally comes with lower, fixed rates; you may even be able to negotiate a lower rate than you had with your original mortgage, making your payments lower than you may have expected. However, if rates have increased, it may not be wise to refinance your entire mortgage. A major downside to a cash-out refinance is that you have to pay closing costs to receive the loan, which can potentially add up to thousands of dollars. Many lenders offer various options so that you don’t have to pay with cash upfront, such as rolling the closing costs into the interest rate, or deducting them from your cash-out funds.

Refinance mortgage originations
Almost $1 trillion of mortgage refinances in 2016 — that number is expected to drop to $553 billion in 2016.

Cash-out Pros: you get a lump sum now; the interest rate should be competitive; interest payments should be tax deductible.

Cash-out Cons: your monthly payments will (almost definitely) increase along with your mortgage balance. You will probably restart at day 1 on your mortgage’s 30 year term. Very significant closing costs since you are getting a new loan for the whole amount. Possible penalties for prepayment of original mortgage. Slow process to close.

Home Equity Loans / Second Mortgages

Many traditional financial institutions offer home equity loans, which allow you to receive a lump sum of cash by taking out an additional loan on top of your existing mortgage. This product is also known as a second mortgage.

Because a home equity loan provides the homeowner with a lump-sum cash payment for the total amount you are approved for, it can be an effective way to pay for large expenses or eradicate high-interest debt. Additionally, some or all of the home loan interest could have the benefit of being tax deductible. However, there is always risk involved when predicting real estate trends and, unless your loan is non-recourse, there is no guarantee that the proceeds you earn from selling your home will fully satisfy all your outstanding liens and obligations related to the home  when it comes time to sell. If your monthly budget is already tight, adding an extra loan payment will drastically impact your finances and defaulting on that debt might mean losing your home.

Home Equity Loan Pros: you get a lump sum now; the interest rate should be competitive (but probably not as good as your first mortgage). Lower closing costs than a refinance. Some of the interest paid may be tax deductible.

Home Equity Loan Cons: new monthly debt obligation. Slow to close. Strict underwriting requirements.

HELOCs (Home Equity Lines of Credit)

Similar to a home equity loan, a home equity line of credit (or HELOC) gives you access to cash using your home as collateral. The major difference between the two products is that rather than providing an upfront lump sum like a home equity loan, a HELOC instead offers a predetermined maximum amount of credit you may use as needed. As you take money out of the line of credit, you subsequently increase your debt obligation.

HELOCs have become increasingly popular as property values rise, particularly in California. In fact, both the Riverside and Los Angeles metropolitan areas rank in the top ten national markets for year-over-year increases in HELOC originations.

HELOCs volume by region
US HELOCs Origination Volume By Region

What can you expect when taking out a HELOC? You may only take out money for a set withdrawal period, usually lasting between five and ten years. Because a HELOC is set up like a revolving line of credit, you may continue to borrow money from the account as you pay off what you’ve already spent. Once the withdrawal period ends, you no longer have access to the funds and the repayment period begins, usually lasting 15-20 years. The upside is that, unlike a home equity loan, you only pay interest on the amount you use. If you’re paying for an expense without a fixed price, such as a renovation or college tuition, a HELOC lets you take out what you need as you need it. Additionally, the interest you pay may be tax deductible up to IRS defined limits, often making this a more attractive option than credit card debt. However, taking out a HELOC comes with a certain amount of risk as well. Most HELOC products have a variable interest rate, meaning your rate may change as corresponding benchmark rates fluctuate. While your introductory rate may start off low, there is no guarantee that it will stay that way.  

HELOC Pros: you get a line of credit now; the interest rate should be competitive right now but….. Lower closing costs than a full refinance. Some of the interest paid may be tax deductible.

HELOC Cons: new monthly debt obligation. Slow to close. Strict underwriting requirements. Variable interest rate. Significant increase in payment obligation at end of draw period.

Reverse Mortgage

A reverse mortgage is a financial product that, like home equity loans, comes in a few varieties. It provides homeowners the option of a lump sum today or payments over either a fixed or variable term. Reserved for homeowners over the age of 62, reverse mortgages have grown in quality and popularity in recent years. One of the challenges homeowners encounter with reverse mortgages is that they have to pay off existing mortgage balances with any money they get from the reverse mortgage. This often means that there’s not much left over for the homeowner after existing obligations are paid off.

Pros: you get a tax-deferred lump sum now; no monthly debt payments; online application; quick closing; cost to you varies with home’s appreciation.

Cons: limited availability; reserved for homeowners over 62; existing mortgage obligations need to be paid off first.

Point Financing

Point offers homeowners an alternative to traditional home equity lending. With Point, homeowners sell a small fraction of their home equity to Point in exchange for a cash lump-sum now.  There are no monthly repayments. Point is paid either when the homeowner buys back Point’s holdings, when the homeowner sells the property or at the end of the term (often 10 years), whichever comes first. At that time, you pay off the original amount in addition to a predetermined percentage of your home’s appreciation.

One of the benefits of using a partner like Point is that it employs broader underwriting standards than traditional banks. Many homeowners are approved with a minimum credit score ranging between 600 and 650. Another key difference is that Point looks at each application in a uniquely holistic fashion. For example, if funds are being used to pay down debt, Point considers your debt-to-income ratio after the debt is repaid, rather than the day the application is submitted.

To get an idea of the type of Point funds you may qualify for, check out the homeowner calculator. You can also fill out a brief questionnaire to determine if you qualify.

Point Pros: you get a tax-deferred lump sum now; no monthly debt payments; online application; quick closing; 10 year term; cost to you varies with home’s appreciation.

Point Cons: you give up some of your home’s appreciation; cost to you varies with home’s appreciation and may be more expensive that a HELOC or home equity loan (it may be less too!).

See if you qualify


Determining Which Home Equity Choice is Best for You

With so many home equity products to choose from, selecting the best fit for your situation can be difficult. Start off by assessing your current and future finances to determine which solution works in your best interest. Consider these questions as you begin to evaluate your options:

  • What is your overall financial situation? Are you overwhelmed by debt? Do you have emergency funds you can access in case of a job loss or other financial setback?
  • What types of short-term and long-term savings goals do you have? Are they affected by the amount of home equity you hold?
  • How long do you plan to stay in your current home?

Next, begin talking to lenders from each type of loan option to determine what you likely qualify for — products like HELOCs have strict underwriting rules. Then compare interest rates, repayment terms, and other factors to determine how much money you can access, what your monthly payments will be, and what upfront costs you will be expected to pay. Do any of these options support the current financial situation and future goals you described above? If the answer is yes, then you may be on your way to successfully accessing the equity you’ve earned in your home.  

Next Steps

With a financing market full of products aimed at homeowners with growing equity, it’s important to be particularly discerning when selecting the right one for you. While traditional lenders offer interest-based products like home equity loans, HELOCs, and refinance cash-outs, there is a growing demand for alternative solutions like Point.

Visit Point to out if you qualify to fund your goals without new monthly payments.

How does Point work?

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