7 alternatives to a home equity loan

One of the biggest benefits of buying a home is that you build equity with each mortgage payment you make. Equity is the percentage of the home that you actually own. You can calculate the amount of equity you have by taking the current value of your home subtracting what you still owe on your mortgage.

One of the ways you can take advantage of having equity built is by using it as collateral to borrow money. You can take out a home equity loan to cover home renovations, consolidate debt, or cover any other major expenses. However, this isn’t the only type of financing available to homeowners. Here’s a quick look at what a home equity loan is, followed by a rundown of seven different alternatives.

Home equity loans: A brief review

A home equity loan is a type of second mortgage that allows you to borrow a lump sum using the equity you’ve built in your home as collateral. Because the loan is secured by your home, it reduces the risk for the lender, which allows them to offer lower interest rates than other loan types.

Home equity loans also typically come with a fixed interest rate, which gives borrowers predictable monthly payments. Loan terms typically range from 5 - 30 years, which can help keep monthly payments affordable.

However, home equity loans also come with potential downsides. Because your home is used by collateral, you could risk foreclosure if you default on the loan. You’ll also need to meet your lender’s score and debt-to-income ratio requirements.

There are also limits to how much you can borrow. Lenders typically allow you to borrow up to 80% to 85% of your equity, minus what you still owe on your mortgage.

Alternatives to a home equity loans at a glance

If you’re a homeowner looking to borrow money but don’t think a home equity loan is right for you, here are some alternative financing options.

7 alternatives to a home equity loans in detail 

Let’s take a more in-depth look at the potential perks and drawbacks of each home equity loan alternative financing option.

1.  Cash-out refinance

With a cash-out refinance, you replace your existing mortgage with a new, larger loan and withdraw the difference in cash. For example, suppose you’re looking to borrow $50,000 and you still owe $200,000 on your mortgage. With a cash-out refinance, you’d take out a new loan for $250,000 to pay off your existing mortgage and receive $50,000.

Unlike a home equity loan or line of credit, a cash-out refinance does not require an additional mortgage payment each month. The balance of your loan increases, but you don’t have to worry about juggling two payments or risking foreclosure.

Pros

• Like a home equity loan, you can borrow a lump sum.
• Fixed interest rate.
• You don’t have to take out a second mortgage.
• You can get a lower interest rate if rates have dropped since you took out your initial mortgage.
• Extending your loan term can help keep your new monthly payment manageable.
• You could deduct the refinanced amount if you use it to improve your home.

Cons

• Higher closing costs than a home equity loan.
• You’ll need to stay in the home long enough to recoup closing costs.
• If interest rates have increased, your new mortgage rate and monthly payment could be higher.
• It can take longer to pay off your loan.

2.  Home equity line of credit (HELOC)

Like a home equity loan, a home equity line of credit (HELOC) is a second mortgage that allows you to borrow money using your home equity as collateral. However, instead of receiving a lump sum, you’ll have access to a line of credit that you can draw from multiple times for a set period of time. Unlike a home equity loan, a HELOC typically comes with a variable interest rate that is subject to change.

A HELOC has two phases – a draw period and a repayment period. The draw period is when you get to access your line of credit as needed, typically while making interest-only payments. Once the repayment period begins, you’ll have to start paying back what you borrowed.

Rocket Mortgage does not offer HELOCs at this time.

Pros

• Lower interest rate than unsecured loans.
• Withdraw as needed during the draw period.
• The amount you borrowed could be tax deductible if it was used to improve your home.
• Long loan term, typically ranging from 5 - 25 years.

Cons

• Comes with a variable interest rate, which means your monthly payments can fluctuate.
• If you can’t keep up with your payments, you’ll risk foreclosure.
• You’ll reduce the amount of equity you have.
• Must meet credit requirements.
• Closing costs.

3.  Reverse mortgage

A reverse mortgage allows homeowners 62 years of age and older to borrow from the equity in their home. Instead of making a monthly payment, you’ll receive a payment – either as a lump sum, monthly installment, line of credit, or a combination of these options. Homeowners get to remain living in the home but are still responsible for homeowners insurance, and property taxes, and maintenance.

A reverse mortgage loan still has to be repaid when the homeowner no longer lives in the home. This is often done by selling the property, which means you wouldn’t be able to leave it to any heirs. Keep in mind that the balance on a reverse mortgage only increases with time as interest and fees are added each month.

Rocket Mortgage does not offer reverse mortgage loans at this time.

Pros

• Instead of making a monthly payment, you can receive a monthly payment.
• Payments are subject to income taxes.
• You get to stay in the home.
• No prepayment penalty.
• You will never owe more than the home is worth.

Cons

• You must be at least 62 years of age.
• The amount of you can borrow is capped at the amount of equity you have.
• You must own the home outright.
• The home must meet property standards.
• You must live in the home as your primary residence.

4.  Personal loan

Personal loans are loans that do not require you to use your home as collateral. As a result, you don’t have to worry about losing your home if you can’t repay a personal loan. However, these loans are riskier for lenders, so they typically come with a higher interest rate than a secured loan. However, personal loans still usually have lower interest rates than credit cards. This can be a good option for homeowners who haven’t built enough equity or don’t want to use their home to secure the loan.

Rocket Mortgage does not offer personal loans, but you can apply for one with our sister company, Rocket Loans.

Pros

• You don’t have to use your home as collateral and risk foreclosure if you default.
• Lower interest rates than credit cards.
• You don’t have to have equity in your home.
• Fixed interest rates.

Cons

• Higher interest rates than secured loans.
• Shorter term lengths.
• Stricter credit requirements.
• Closing costs required.

5.  Personal line of credit

A personal line of credit works like a personal loan. However, instead of receiving the money in a lump sum, you gain access to a revolving line of credit that you can draw on as needed for a certain period of time. A personal line of credit is like a HELOC that’s unsecured. That means you don’t have to use the home as collateral, but you’ll likely have to pay a higher interest rate as a result.

Pros

• Withdraw funds as needed over the course of the draw period.
• You don’t have to use your home as collateral.
• You only have to make interest payments during the draw period.
• Use the money for whatever you wish.

Cons

• Variable interest rates.
• Higher interest rates than HELOCs.
• Origination fees.
• Strict eligibility requirements.
• Interest isn’t tax deductible.
• You may have to pay a fee every time you withdraw funds.

6.  Rent-back agreement

A rent-back agreement allows you to sell your home while continuing to live in it for several weeks or months. It's a contract to sell your home to a buyer while keeping the right to live in it as your primary residence for a set period. This agreement can provide the necessary funds to buy or build your next home while giving you time to set up new living arrangements.

Pros

• You don’t have to take out a loan and borrow money.
• Use the funds from the sale of the home as your financing solution.
• It’s not a long-term obligation.

Cons

• You lose equity by selling your home.
• When you go from owner to tenant, you’re subject to the new owner’s tenancy terms.

7.  Home equity sharing agreement

A home equity sharing agreement lets you trade your future equity for a lump sum. The agreement estimates your home’s future market value in the future and sets a date between 10 - 30 years from the present for the homeowner to repay the lump sum.

Homeowners most commonly use home equity sharing agreements for debt consolidation and home improvements. Just know that you will need to be able to repay that lump sum at the agreed-upon date or you may have to sell your home to do so.

Pros

• Convert future equity to cash now.
• No monthly payment required.
• No interest charged.
• Easier qualification requirements.

Cons

• You sacrifice equity.
• Future lump sum payment required.
• Higher total cost than home equity loan.

The bottom line: Explore all your home equity options

While a home equity loan is one financing tools homeowners can utilize, it’s not your only option. Whether you choose a HELOC, cash-out refinance, personal loan, or other type of financing, it’s important to know that each come with potential perks and drawbacks. The right choice for you will depend on your financial situation and goals.

Whether you’re looking to consolidate debt or redo your bathroom, applying for the financing option that fits your situation is the next step. If a refinance best fits in with your financial goals, we can help you get started on the refi process today.

Refinancing may increase finance charges over the life of the loan.