6 Home Equity Loan Alternatives To Consider
January 29, 2024 8-minute read
Author: Kevin Graham
You’re looking at consolidating debt or doing a home improvement project and have thought about a home equity loan or line of credit. While you have considered them, you may also be looking into home equity loan alternatives. After all, a home equity loan would mean a higher rate than a cash-out refinance while still having to use your home as collateral. You may also be interested in funding flexibility provided by other options.
6 Alternatives To Home Equity Loans And HELOCs
A home equity loan involves a lump sum payment using your home as collateral. A home equity line of credit (HELOC) has a period where you can draw from it like a credit card and only make interest payments followed by a repayment period where the balance freezes and you repay the portion of the credit line that you’ve used, plus interest.
Whether you should go with a home equity loan or HELOC often comes down to math. That’s because it’s a second mortgage, so you’ll have two payments at different interest rates.
If it makes sense to do this or go with an alternative like a cash-out refinance depends on the blended rate. You do a weighted average on each of the loans and figure out which way you could save more money. You’ll also want to make sure you have enough equity to accomplish your goals. You can often convert up to 90% of your equity to cash if you qualify for a home equity loan.
Home equity loans tend to have fixed rates. HELOCs, on the other hand, have variable rates. This means the rate will fluctuate with market interest rates in the same way a credit card would.
Beyond the math, it’s important to note that because your home is collateral, if you’re unable to make the payments, there is a risk of foreclosure. No one ever plans on financial trouble, but it’s something to consider because we’ll also talk about several options not involving collateral.
If you would like to look into a Home Equity Loan, these are offered by Rocket Mortgage®. However, we don’t offer HELOCs at this time. You can also check out one of these alternatives.
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1. Cash-Out Refinance
A cash-out refinance involves replacing your current mortgage with a new one with a higher balance. You receive the difference between the new balance and the original balance in cash. The rate is also lower than what you would get on a home equity loan or HELOC because you’re refinancing your primary mortgage, making it less risky for lenders.
As mentioned above, whether it makes sense to do a refinance or a home equity loan can depend on the blended rate and how the monthly payments add up. It’s also important to consider your home’s value. In some instances, you may be able to access more equity through a second mortgage.
Because it’s a new mortgage, you have the opportunity to potentially lock in a lower mortgage rate or switch from one that’s adjustable to fixed. You can also change your repayment term, shortening it to save on interest or going longer for a more affordable monthly payment. You’ll also get a lower rate because it’s based on your primary mortgage.
Unless you qualify for a VA loan, you’ll need to leave at least 20% equity in the home after taking cash out, so you’ll want to make sure you have enough. If rates are higher than when you last closed on your mortgage, your rate will be higher. It’s also important to be aware of closing costs. Finally, because a home valuation is required, it’s not the fastest option.
2. Reverse Mortgage
A reverse mortgage allows homeowners 62 and older to borrow against the equity in their home. However, instead of you having your mortgage payment, the mortgage company pays you.
The existing mortgage is paid off first and you’re responsible for taxes, homeowners insurance and home maintenance. You can be paid in a lump sum, monthly payments or in the form of a line of credit. It’s possible to get a combination of the three.
Of course, the loan does have to be paid back eventually, but not until the last homeowner (borrower or non-borrowing spouse) moves out, passes away or sells the house. At that point, you have a few options:
- Refinance it into a traditional mortgage: If your heirs wish to keep the home and don’t independently have the funds to pay off the balance, they can refinance it into a traditional mortgage.
- Sell the home: You can choose to sell the home and keep the difference between the mortgage balance and the proceeds from the sale. Keep in mind, a home equity conversion mortgage (HECM) is a the most popular type of reverse mortgage that is also a nonrecourse loan. With this reverse mortgage, you’ll never owe more on the loan than the home is worth. If the home sells for less than what is owed, you or your heirs will not be responsible for paying the difference.
- Give the home back: You can simply sign the home over to the lender and walk away. Neither you nor your heirs can be held responsible from a financial or credit standpoint if you choose this option.
Rocket Mortgage does not offer reverse mortgages at this time.
This is an option allowing you to access your equity without a monthly payment. Additionally, there is no penalty for you or your heirs if they just give the property back when you pass or move out.
Your loan amount is limited by your existing home equity as well as your age. Equity is reduced by the amount of your loan. You’re also required to go through financial assessment to make sure you can handle the maintenance, insurance and taxes. If not, this will be put in escrow for you. Other fees like closing costs and mortgage insurance come out of your proceeds and you’ll first need to use those proceeds to pay off your existing loan.
3. Personal Loan
A personal loan is a one-time payment given to you strictly on the basis of your finances and creditworthiness. There’s no collateral required. The loan is paid off in installments over the course of your loan term. There are typically origination fees associated with these loans. The good news is that can be used for pretty much anything you want.
Personal loans can be funded as quickly as the same day you apply. There are also typically at least a couple of different term options you can select to match your budget. Fixed interest rates are common, and you don’t have to put up any collateral.
Because there’s no collateral associated with this loan, the rates tend to be higher than on something like a mortgage. The credit requirements are also stricter and there are shorter repayment terms. Finally, origination fees are taken out of your loan proceeds.
4. Personal Line Of Credit
A personal line of credit isn’t secured by anything, so it may sound a bit like a credit card. However, it functions like a HELOC without the collateral. You have the draw period at the beginning of the loan and you’re only required to make interest payments. Then the repayment period starts and you pay back the balance with interest.
The big advantage of a personal credit line is that you have the flexibility to take funds out, put them back and access them again during the draw period. A good example of when this would make sense is for home improvement projects. For example, you could put in new windows, put the money back into the credit line and use it again to redo your siding.
One of the downsides here is that, like a HELOC, there are variable interest rates that change with the market. This also means the monthly payment can change. There are also origination fees for closing the loan to think about.
5. Rent-Back Agreement
A rent-back agreement (also called a sale-leaseback) is one in which a homeowner sells their home while also contracting to rent the property back from the buyer. Although there is no age restriction, this is often used by seniors to gain the financial benefit of selling their home while still living there. You do have the monthly payment, though, and no equity is retained.
A rent-back agreement allows you to gain the cash infusion you would get from selling your house while still living in it. You don’t have to find a new house. It’s also not a loan, so if you do decide to move, there is no long-term financial obligation.
The downside of a rent-back agreement is that the house is no longer yours, so you will lose all equity. Also, you have to get permission to make any changes to the home. This may not be a good option if you want to make major renovations after the sale.
6. Home Equity-Sharing Agreement
In a home equity-sharing agreement, you contract with a company to give you a loan based on the equity in your house. Instead of a monthly payment, the company agrees that you’ll pay back the loan at the end of the term and give them a portion of whatever equity was gained in the house over that time. You’re giving an investor a temporary stake in your home.
This allows you to convert existing equity into cash without having to take out a traditional loan. This keeps debt down while allowing you to accomplish your goals, whether that’s home improvement, debt consolidation or something else entirely.
The downside to home equity sharing is the equity you will eventually have to give up no matter what. Even if you pay off the loan at the end of the term, you have to pay the financing company for equity gained over that time based on the ownership stake they had. Additionally, there are some other fees that go along with this because you’ll need to get an appraisal to have the value of your home verified.
The Bottom Line
While a home equity loan can be one good option for homeowners looking to access their existing equity, not everyone wants to take on a second mortgage payment and the math doesn’t always make sense. Taking cash out can be a good alternative because it’s typically a lower rate relative to other options.
If you don’t want to touch your mortgage at all, there are several options including everything from personal loans to home equity sharing agreements. Carefully weigh your options and don’t be afraid to speak to a financial advisor.
If you decide a cash-out refinance or Home Equity Loan is indeed the right option for you, we’re here to help. You can get started by applying online.
1 Home Equity Loan product requires full documentation of income and assets, credit score and Max LTV/CLTV/HCLTV. Requirements are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 75%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 760 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 45% or below. Valid for loan amounts between $45,000.00 and $350,000.00 (minimum loan amount for properties located in Iowa is $61,000). Product is a second standalone lien and may not be used for piggyback transactions. To qualify for these loan programs, you must be the age of majority in your state with a valid U.S. residency. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “Higher Priced” based on the APOR spread test. Higher Priced loans are not allowed on properties located in New York. Formal approval will be subject to satisfactory verification of income, assets, credit, property condition and value. Additional restrictions apply. Not available in Texas.
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