Many finance professionals find themselves answering client questions about accessing cash to pay for major expenses. Tapping into home equity remains a popular way to cover a variety of needs, from home improvements, college tuition and medical bills to consolidating credit card debt.
The attractiveness of home equity financing depends primarily on rising home values and low interest rates. Growth in home values should Continue, but the current environment of high inflation and rising interest rates is reducing consumer purchasing power. And federal rate hikes to control inflation have already begun, which usually means higher mortgage rates, making home equity financing more expensive.
Some financing options may be less attractive than they were a few months ago, while others retain their appeal. Four of the most common types of equity financing are home equity loans, home equity lines of credit, mortgage refinance, and home equity investments. Each has its advantages and disadvantages when considering general economic conditions and the overall financial situation of your customers.
Home Equity Loan
Home equity loans allow homeowners to borrow a lump sum for large, planned expenses, such as home renovations. Homeowners need good credit scores, sufficient income to qualify, and funds to cover closing costs — generally 2% to 5% of the total amount of the loan. Interest rates for home equity loans are fixed.
From August 2022rates range between 3% and 12% depending on the qualifications of the borrowers. If federal rate hikes continue, those rates could rise as well. Homes are used as collateral in equity loans, so homeowners need to ensure they can afford monthly repayments until the loan balance is fully paid off.
Home Equity Line of Credit (HELOC)
With HELOCs, homeowners can take amounts out of their net worth (up to the maximum approved amount) to pay for major current expenses, such as college, or unexpected expenses, such as unexpected home repairs or medical bills. . Good credit and minimum income requirements also apply to qualify for HELOCs, and homeowners must pay closing costs.
HELOC interest rates are variable, which could cost borrowers more if mortgage rates rise. Fixed monthly payments are only due on the amount withdrawn. But, like home equity loans, HELOCs use the borrower’s home as collateral, so homeowners only have to borrow what’s needed and keep up with monthly repayments. Additionally, HELOCs present additional risk if the borrower’s home loses value, reducing their line of credit – and their financial cushion.
A “cash-in” mortgage refinance allows homeowners to pay off their first mortgage and replace it with a new mortgage, usually at a lower fixed interest rate. They receive a cash lump sum equal to the difference between the two loans. But closing costs and cash refinance fees are higher than for home equity loans or HELOCs, because lenders have to generate a whole new mortgage. Still, cash refinances offer a way to use up equity without taking out a home equity loan, which is essentially a second mortgage. However, with the global rise in mortgage interest rates, it can be difficult to find a lower interest rate on an existing mortgage in today’s market.
Investing in Home Equity
Home equity investments offer a lesser-known but innovative way to tap into equity. They allow homeowners to get cash in exchange for a share of the future value of their home, and the house secures the investor’s interest. Qualifying requirements differ from those of traditional refinancing, and homeowners don’t have to worry about monthly payments or interest charges with a capital investment – just valuation fees, origination fees and closing fees. To settle the investment, the owners to buy the investor’s share after a set period 10 to 30 years or whenever they decide to sell or refinance their home before then.
Contrary to funding options that include specific criteria on how the funds are usedHome equity investments allow homeowners to use the funds for any reason, making them a flexible option. Some use the money for small business opportunities, diversifying their portfolio, eliminating debt, or paying school fees, but the possibilities don’t stop there.
Here are four more ways your clients can use home equity investments:
Investments in home equity can provide the money for a down payment and closing costs for a vacation home. Today, most real estate investors do not distinguish between a vacation home or an investment property and do not restrict the use of funds.
- Home renovations for future sale
Home equity investments can be a smart way to fund renovations that increase the value of a home for later sale, especially for homeowners with sufficient equity but below-average credit scores. . With the upfront money, they can cover that basement conversion or new flooring without adding to their debt load.
- Alternative to the bridging loan
Homeowners use bridge loans to obtain short-term cash to purchase another home before selling their current home or for the costs of flipping a property. However, bridge loans usually come with high interest rates and origination fees. A home equity investment can be an attractive alternative to a traditional bridge loan. Financing an equity investment only takes a few weeks, compared to a few days for a bridge loan, but real estate equity investments could be a smart alternative if owners don’t need the money so quickly.
Investing in real estate and building a portfolio can help generate passive income and diversify assets. However, getting started comes with a hefty price tag for down payments, closing costs, insurance, and potential repairs. An investment in home equity can help finance an investment property without the stress of interest, monthly payments or debt.
Inflation and higher interest rates are making it harder for owners to absorb the costs associated with traditional equity financing. Some refinance options may be less attractive than a few months ago, so it’s important to consider high inflation and changing interest rates when recommending different options. With home equity investments, your clients can still leverage their equity for those big expenses without the stress of monthly payments, interest charges or debt.
Gregg Damiano is Director of Channel Sales for Hometap.