Equity is the value of the portion of your home that you already own, which you may choose to borrow against at some point during your home ownership. There are three ways of doing this:
- A second mortgage (a lump sum payment)
- A home equity line of credit (HELOC)
- Refinancing of the mortgage
All three of these methods have their pros and cons, which we will detail below.
A second mortgage is a loan that you can take against the equity of your home, using that very home as collateral. With a second mortgage, you may borrow up to around 80% of the value of your home.
The Benefits of a Second Mortgage
- An easily managed one-time lump sum payment
- Lower interest rates than many credit cards and types of loans
- Typically has less requirements than a first mortgage
- Lump sum payments are ideal for large expenses, like school tuition
The Disadvantages of a Second Mortgage
- Must be paid monthly, alongside the first mortgage
- House faces the risk of foreclosure in the event of default
- Requires the payment of closing costs and other associated fees or penalties
Home Equity Line of Credit
This is a type of second mortgage, but rather than getting one lump sum amount the homeowner has access to their home’s equity through an ongoing line of credit.
The Benefits of a HELOC
- Ideal for home improvement projects, where materials are often bought over time
- Grants you access to your home’s equity when you need it
The Disadvantages of a HELOC
- It can be difficult for some people to manage their finances when not awarded a lump sum loan payment
- Like with lump sum second mortgage loans, the risk of foreclosure is very real if the homeowner defaults on their repayment
Refinancing a Mortgage
The process of mortgage refinancing essentially entails the redefining of the terms of the mortgage. A loan is taken out to the value of the mortgage, and then a new mortgage with new interest rates and other terms is applied to the property.
The Benefits of Refinancing
- Homeowners can renegotiate their mortgage interest rate, often resulting in a lower rate
- Grants access to the equity of your home
The Disadvantages of Refinancing
- Has closing costs that must be paid
- You may have to pay for terminating your mortgage contract early as a part of refinancing
All three of these options grant homeowners access to the accumulated equity of their homes, but all come with different conditions that must be met and pitfalls that one should be made aware of before they make a decision.