7 home equity loan options to consider

Home equity loan alternative quick guide

7 Home equity loan options to explore 

Home equity loans are second mortgages homeowners can take out on their home. Most lenders will only provide loans that create a total debt load of 85% of your home value. In other words, your original mortgage and your home equity loan (which is a second mortgage) can’t surpass 85% of your home’s market value.

A home equity loan is provided in a lump sum that borrowers can use for any purpose. For instance, you can renovate your home, consolidate high-interest debt or start a business. However, because the loan becomes a second mortgage and uses your home as collateral, homeowners might prefer options with less risk or different payment structures. Here are the other options to consider.

1. Cash-out refinance

A cash-out refinance is another way to tap your equity. It differs from a home equity loan because it replaces your original mortgage with a new one. For example, if you have a $300,000 home and $150,000 left on your mortgage, you have $150,000 of equity.

A cash-out refinance allows you to borrow from some of that equity. If you took out $75,000 from that equity, your new mortgage would be $225,000. You’ll also get a new interest rate and payment schedule.

Pros 

• Lower rate: Refinancing means getting a new interest rate based on current market conditions. If current conditions present a rate that’s lower than the one you currently have, you’ll get a lower mortgage rate. As a result, you would pay less interest in the long run, reducing housing costs.
• Restructured term: Cash-out refinances can shorten or elongate your loan term, depending on your preferences. A shorter term usually equates to a higher monthly payment and less interest expenses over time. On the other hand, a longer term can lower your mortgage payment so it’s more budget-friendly. 
• Multipurpose: Like a home equity loan, a cash-out refinance is usable for any financial purpose.
• Tax benefits: You may be able to deduct the refinanced amount if you use it to improve your home. 

Cons

• Equity requirement: You can typically refinance a loan up to 80% of your home equity, limiting your borrowing capability. VA loans are the exception to this rule, where you can tap 100% of your equity.
• Closing costs: Because a cash-out refinance is a mortgage, you’ll pay closing costs like you did with your original mortgage. These upfront costs usually run between 3% and 6% of the loan amount.

2. Home Equity Line Of Credit (HELOC)

A home equity line of credit (HELOC) is another tool that taps your home equity. In this case, you turn your equity into a balance you can draw funds from over a span of time known as a “draw period,” usually lasting 10 years. This can be more practical than a home equity loan because you can withdraw smaller sums as needed over a longer period.

Pros 

• Multipurpose: Like other options in this list, HELOCs are usable for all purposes.
• Consolidate debt: HELOCs usually have lower interest rates than other debt types, making them ideal debt consolidation tools.
• Withdraw as you go: HELOCs provide access to equity over many years, allowing you to take money out as you need it. This feature helps prevent homeowners from borrowing more than necessary.
• Tax deduction: You might be able to deduct the interest on the borrowed amount if you use it for home renovations and improvements.

Cons

• Upfront costs: Homeowners must pay fees for origination, a home appraisal, a title search, and attorney services, which impose a financial burden from the start.
• Rates may increase: Interest rates on HELOCs in their repayment period fluctuate with the market. Rates typically increase when the draw period ends. As a result, you could end up with an unaffordable monthly payment.

3. Reverse mortgage

A reverse mortgage allows homeowners 62 and older to borrow from the equity in their home with no monthly repayment required. Homeowners are still responsible for paying homeowners insurance and property taxes and maintaining the home.

Instead of the homeowner paying their lender, the lender provides the homeowner with monthly installments, a lump sum, or a line of credit to use as they wish. Primary homes are the only eligible property type for this financial tool and the borrower can own the home free and clear or have a current mortgage on it.

Rocket Mortgage^® doesn’t offer reverse mortgage loans at this time.

Pros 

• No monthly payment: Unlike the other options so far, the reverse mortgage doesn’t come due until you move out of the home, sell the home, or pass away.
• No penalty: Reverse mortgages don’t impose a penalty if the homeowner passes away or moves out. Instead, the homeowner can sell the home to repay the lender – keeping any remaining profit. The homeowner or heirs can also give the home to the lender. If the reverse mortgage is a home equity conversion mortgage (HECM), it’s a nonrecourse loan. That means, the borrower will never owe more than the home is worth.

Cons

• Loan amount limitation: Lenders base the reverse mortgage on the homeowner’s equity. So, if you have $200,000 of equity, your total reverse mortgage amount won’t surpass this limit. And if you have an existing mortgage, your proceeds will first go toward paying off that loan.
• Financial assessment: Borrowers must go through a financial assessment before they are approved for this type of mortgage. The reverse mortgage requirements include being at least 62 years old, attending a HUD-approved financial counseling session, having at least 50% equity, and meeting minimum property condition standards.

4. Personal loan

A personal loan can finance any need or project. While a home equity loan is tied to your house, a personal loan doesn’t require collateral. This means you don’t risk possession or property loss if you fall behind on loan payments. It’s a key difference between a home equity loan and a personal loan.

Pros 

• Term options: Personal loans are usually shorter than mortgages. Typically, you’ll have around 36 months to repay a personal loan, although longer terms are available.
• No collateral: Personal loans do not require collateral, so you can’t lose property, vehicles, or valuable possessions if you default on the loan.

Cons

• Higher rates: The lack of collateral for personal loans is a double-edged sword because lenders charge higher interest rates instead.
• Strict credit requirements: Likewise, the absence of collateral means that lenders have stricter credit requirements for personal loans. This way, they screen out borrowers with shakier borrowing histories.

5. Personal line of credit

A personal line of credit is a financial account you can withdraw from as you go. While a HELOC uses your home as collateral for a line of credit, a personal line of credit doesn’t require collateral. So, it has the perks of a HELOC without risking losing your home.

Pros

• Access to funds: Borrowers can access their funds throughout the draw period. This perk makes a personal line of credit a convenient source of funding over time.
• Multipurpose: Borrowers can use this tool for a wide range of purposes, such as debt repayment or home repairs.

Cons

• Variable interest rates: Like HELOCs, personal lines of credit have variable interest rates, creating unpredictable monthly payments.
• Origination fees: Closing on a personal line of credit comes with origination fees, meaning borrowers must have thousands of dollars upfront to afford this financial tool.

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 

• Obtain cash: Generally, the agreement takes effect after closing day and the purchase of the home, providing cash to the seller.
• No long-term obligation: Rent-back agreements aren’t loans. Instead, you’ll pay the buyer an agreed-upon monthly rental fee with no long-term financial obligation.

Cons

• Lose equity: This option requires you to sell your home. As a result, you’ll lose your equity because you’re no longer the owner; instead, you’re a tenant.
• Permission to make changes: As a tenant, you’ll need permission from the new owner to make any home renovations.

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 market value in the future and sets a date between 10 and 30 years from the present for the homeowner to repay the lump sum.

A home equity loan has a monthly installment with an interest rate. Instead, this agreement requires an amount of your equity after a certain period of time elapses.

Pros 

• Convert equity to cash: Your equity becomes a lump sum for immediate use for any purpose.
• Reduces debt: A home equity sharing agreement doesn’t add a debt payment to your monthly budget. In its place, you have a future obligation to send the investment company a portion of your equity.

Cons

• Give up equity: The agreement gives an investment company ownership of some of your equity. The upper limits of these agreements can be hundreds of thousands of dollars, meaning you might part with all of your equity.
• Additional fees: Home equity sharing agreements are expensive to create because of fees for origination, an appraisal, a home inspection, title company costs, and using an escrow account.

The bottom line: There are many ways to get a lump sum

You have many options with unique features in the lending market to finance your goals. Each has its perks and pitfalls, so understanding your options is crucial.