TAPPING HOME EQUITY

There are any number of reasons why you might want to tap the equity in your home. Perhaps you want to make improvements to your home, pay off high interest credit cards, finance your child's college education, or buy a high-ticket item such as a car or boat. Or maybe you simply want to have extra cash available to you.

There are a variety of ways for you to tap your home's equity, and each of them has its advantages and disadvantages.

Refinancing your mortgage:

Many people refinance their mortgages for more than the principal balance, so that they can take some cash out of the refinance. This makes sense when the interest rate offered by the lender is one to two points less than the interest rate you're currently paying.

Refinancing when you reduce your interest rate by less than one percentage point does not make sense. The cost of the refinancing will outweigh the savings gained by such a small rate decrease.

Refinancing your mortgage also means that you'll be starting over, just as if you were applying for a mortgage for the first time. You'll be offered the same fixed rate or adjustable rate packages, and you'll pay the same types of closing costs.

You'll also be starting over with the amount of your monthly mortgage payment applied to the principal balance. The amount of your monthly mortgage payment that is applied to your principal balance increases over time. With a mortgage refinance, you start over by paying more in interest than you do in principle each month.

Consider tapping your home's equity by refinancing only when interest rates are significantly lower than what you're currently paying. And, if you do refinance, consider doing a shorter term mortgage so that you will pay down the principal balance more quickly.

For more information about mortgage refinancing, see our refinancing page.

Home equity loan:

Rather than tapping home equity by refinancing a mortgage, you might want to consider a home equity loan. With a home equity loan, you don't face the same closing costs as you would with refinancing, and the principal/interest payment balance on your current mortgage remains the same.

A home equity loan is entirely separate from your mortgage. Usually the interest rates for equity loans are higher than for mortgages, and the terms of the loans are generally shorter.

Home equity loans are best used for specific purposes, such as home improvements or other purposes for which you know the amount of cash you need.

As with any loan, a home equity loan will be part of your credit record, and will affect your ability to obtain credit in the future.

Home equity line of credit:

If you'd like to have money available to you when you need it, tapping your home equity through a line of credit may be the best way to go.

A home equity line of credit allows you the flexibility to borrow the amount of money you need, and at the time you need it. Some borrowers open home equity lines of credit simply to have the money available to them in case of emergencies.

Home equity lines of credit often have lower interest rates than home loan refinancing. However, lines of credit are similar in many respects to credit cards. While the interest rates on home equity lines of credit are lower than credit card rates, the rates on lines of credit can rise or fall.

Lenders will typically extend a line of credit for a fixed period of time. After that period, the lender may or may not renew your line of credit, or may renew it at a different interest rate.

For more information, please see our home equity line of credit page.

FHA home improvement loans:

If you're considering tapping home equity to make alterations to your house, you should definitely look into an FHA home improvement loan.

The Federal Housing Administration (FHA) does not actually issue loans, but insures loans issued by FHA-approved lenders. Because the loans are insured by the FHA, you may be able to get a lower interest rate than you would from traditional refinancing or home equity loans.

Another advantage to FHA home improvement loans is that they're often available to those whose financial situations would disqualify them from obtaining loans not backed by the FHA.

FHA home improvement loans have restrictions on the amount of money you can borrow, on what type of home improvements the loans can be used for, on how long the term of the loan can be, and on borrower eligibility.

For more information, please see our FHA home improvement loan page.

Reverse mortgages:

If you're over the age of 62, and are looking to tap the equity in your home, you might consider a reverse mortgage. With a reverse mortgage, you can borrow money for a variety of purposes, from home improvements to providing additional retirement income. You can choose to receive monthly payments, a single-purpose loan, or you can open a line of credit.

With a reverse mortgage, you're reducing the amount of equity you have in your home. Thus the term "reverse." Reverse mortgages are tailored to those who have significant equity in their homes, but do not have a lot of cash.

Reverse mortgages are available from private lenders, and are also available through a program from the U.S. Department of Housing and Urban Development.

Also called Home Equity Conversion Mortgages (HECM's), reverse mortgages have certain restrictions on eligibility, purposes for which the mortgages can be used, and amounts of money that you can borrow.

For more information, please refer to our reverse mortgages page.

Tapping home equity is not something to be taken lightly. For most people, their homes are their most valuable asset. Reducing the amount of equity you have in your home can have long term implications.