Goodspeed: Tapping into your home’s equity

LINDA GOODSPEED
CORRESPONDENT
Home values have soared since the pandemic, leaving homeowners with a lot of equity to tap.

QUESTION:With interest rates so low and home values going up, I would like to tap some of my home equity and put it toward my son and daughter’s education. What is the best way to do this?

ANSWER: As you pointed out, home values have soared since the pandemic, leaving homeowners with a lot of equity to tap. There are three ways to do this, each with different advantages and downsides.

The first way to get at your home’s equity is a cash out refinance. With a cash out refi, you take out an entirely new mortgage. Most lenders will allow you to borrow only up to 80 percent of the home’s value for more than what you owe on your current mortgage. You then pocket the difference between the two mortgages in cash.

For example, let’s say you own a $500,000 home and you still owe $200,000 on your mortgage. If you get approved for a new mortgage for $400,000, you would be able to pocket the extra $200,000, minus closing costs.

Closing costs typically range between 2 percent and 5 percent of the loan’s value, depending on the lender.

The obvious benefit of a cash out refi are the current low interest rates. With 30-year interest rates hovering below 3 percent, a cash out refi is a cheap way to borrow money.

The one time you don’t want to do a cash out refi is to get a mortgage rate higher than what you are currently paying.

A second way to tap the equity in your home is through a home equity line of credit (HELOC). This is a line of credit that allows you to borrow money against your home. You have a set limit on how much money you can borrow, usually up to 85 percent of your equity in the home.

The nice feature about a HELOC is that you pay interest only on the money you borrow, which is especially good if you don’t know how much money you need – for example, a home improvement project where costs can fluctuate.

The main drawback to a HELOC is that it has a variable interest rate, currently ranging from about 3.5 percent to 8.6 percent, depending on your credit score, which means your monthly repayment amount will also vary, especially if the Federal Reserve starts to raise interest rates.

If you know exactly how much money you need to borrow, you might consider a home equity loan. With a home equity loan, you receive a lump sum of cash (usually up to 80 percent of the equity in your home) and pay it back in installments over a period of time, ranging from 5 to 30 years. The main benefit is that it comes with a fixed interest rate so you know exactly what your monthly repayment amount will be.

The drawback is that most home equity loans come with an interest rate higher than a HELOC (at least at the beginning of the HELOC).

Linda Goodspeed is a longtime real estate writer and author of “In and out of Darkness.” Email her at: lrgoodspeed@comcast.net.