How do I get a home equity loan on house that is paid off?
Owning a mortgage-free home is a huge step toward financial freedom. There might come a time when tapping into your home’s equity becomes a necessary and practical option.
If you make that decision, there are smart, fiscally sound ways to access a home equity loan on a paid-off house.
Can I get a home equity loan for a paid-off house?
Yes, you can get a home equity loan on a fully paid-off house. These loans (more commonly known as cash-out refinance) let you borrow against your home’s value, providing a lump sum of cash you can use however you’d like.
Because your paid-off home serves as collateral, lenders often offer lower interest rates on home equity loans —than on other borrowing options.
Pro tip: While many lenders don’t offer a home equity line of credit (HELOC) in the first lien position, Axos Bank does—so you can also access your equity through a HELOC on your paid-off home rather than through a home equity loan.
When should you get a home equity loan on a paid-off house?
Home equity loans can be a wise choice in several scenarios:
Home Improvement: Are you dreaming of a modern kitchen or a backyard oasis? Many homeowners choose a home equity loan to fund renovations that boost their home's value. Imagine updating that outdated kitchen, adding an extra bathroom, or building a new deck—all made possible with upfront funds at a great fixed rate.
College Tuition: Higher education can be costly, and student loans often have high interest rates. Why not use your home's equity to invest in your child's future? A home equity loan usually offers lower rates, helping avoid the student debt trap.
Debt Consolidation: Struggling with multiple high-interest debts? Simplify your life by consolidating them into one manageable home equity loan. With a single monthly payment and a better interest rate, you'll pay less overtime and regain control over your finances.
Starting or Expanding a Business: Entrepreneurs often face significant startup costs or need capital to expand. A home equity loan can provide the necessary funds while allowing you to retain ownership of your business without attracting outside investors.
Medical Expenses: Life is unpredictable, and medical bills can accumulate quickly. If your insurance falls short, a home equity loan can bridge the gap, ensuring you get the care you need without financial strain.
Emergency Fund: Peace of mind is priceless, and having an emergency fund is crucial. A home equity loan offers a flexible solution, giving you access to funds when unexpected expenses arise without dipping into your savings.
Liquidity (with a HELOC): A home equity line of credit (HELOC) allows you to access funds as needed. Many lenders require a minimum draw at closing, but once that's repaid, you can continue to borrow from your credit line during the draw period (typically 5 to 10 years). It's a flexible option for homeowners wanting ongoing equity access.
Steps to Get a Home Equity Loan on a Paid-Off House
Next, let’s walk through the four steps to secure a loan on your paid-off house, allowing you to make informed decisions about your unique financing options.
Step 1: Evaluate Your Financial Situation
Before you start exploring home equity borrowing options, it's crucial to have a clear understanding of your financial health. Ask yourself these questions:
Why do I need a loan?
Can I comfortably afford the monthly payments?
How does this loan align with my long-term financial goals?
Answering these questions will help ensure that taking out a home equity loan is a wise decision and won't lead to financial strain.
Step 2: Shop Around for Lenders
Not all lenders offer the same terms or rates on home equity loan options. It's essential to research multiple options and compare them to find the best fit for your needs. Key factors to consider include:
Interest Rates: Fixed-rate home equity loans provide stability with consistent monthly payments, while variable rates can fluctuate.
Loan Terms: Different lenders offer varying repayment periods. Choose one that aligns with your budget.
Fees: Look out for application fees, origination fees, and any prepayment penalties.
By comparing these elements, you can identify a home equity loan lender that offers competitive loan rates and terms.
Step 3: Gather Necessary Documentation
To streamline the application process, gather all required documentation ahead of time. Lenders typically request the following:
Proof of Income: Pay stubs, tax returns, or bank statements to verify your ability to repay the loan.
Credit History: A credit report to assess your financial reliability.
Property Details: Information about your home, including its size, age, and features.
Having these documents ready will help expedite your application and minimize potential delays.
Step 4: Apply for the Loan
Once you've chosen a lender with favorable conditions, it's time to apply. Follow these steps:
Submit Your Application: Provide accurate information on the application form. Any discrepancies can lead to delays or denials.
Appraisal: Be prepared for an appraisal to determine your home's current market value. This evaluation helps the lender decide how much they are willing to lend you.
Review and Sign: Once your application is approved, carefully review the loan agreement. Make sure you understand all terms and conditions before signing.
Pros and Cons of Home Equity Loans
Like any financial product, home equity loans come with their own set of advantages and disadvantages.
Understanding these can help you make an informed decision about whether this borrowing option is best for you.
Four Pros of Home Equity Loans
Lower Interest Rates: Because they are secured by your home, lenders are more willing to offer competitive home equity loan rates. This can lead to significant savings over the life of the loan.
Fixed Monthly Payments: If you're someone who likes predictability when it comes to finances, a fixed-rate home equity loan might be appealing. With fixed monthly payments, you can budget more effectively without worrying about fluctuating interest rates.
Potential Tax Deductions: Under certain circumstances, the interest you pay on a home equity installment loan might be tax-deductible. However, be sure to consult with a tax advisor to understand how these rules apply to your specific situation.
Access to a Large Sum: From a major renovation to consolidating debt to covering educational expenses, a home equity loan gives you access to a large sum of money. This can be particularly beneficial for covering significant expenses that require immediate attention.
Four Cons of Home Equity Loans
Risk of Foreclosure: Of course, the primary risk associated with home equity borrowing options is the possibility of foreclosure. It's crucial to look at your financial situation honestly and know you can meet the repayment terms before committing to this type of loan.
Closing Costs and Fees: Home equity loans often come with appraisal fees, application fees, and other administrative costs, which can add up quickly. Read the fine print and consider these expenses when calculating the total cost of financing.
Long Repayment Terms: While longer repayment terms may result in lower monthly payments, they can also mean paying more interest over time. Weigh the benefits of lower payments against the potential for increased overall costs due to extended loan terms.
Reduced Home Equity: Don’t forget -- borrowing against your home's equity reduces your ownership stake in your property. That could impact your ability to sell or refinance in the future. And if the housing market takes a downturn, you may find yourself owing more than your home is worth.
Other Ways to Tap into the Equity of a Paid-Off House
If you're looking to fund a renovation, consolidate debt, or supplement your retirement, there are different ways to tap that equity. Here are some of the most popular options:
Home Equity Line of Credit (HELOC)
While a home equity loan provides a one-time lump sum with fixed payments, a HELOC offers ongoing access to funds, similar to a credit card. Borrow as needed during the draw period, paying interest only on the borrowed amount. It's ideal for ongoing expenses, though variable rates may increase future payments.
Reverse Mortgage
For homeowners aged 62 and older, a reverse mortgage converts equity into cash without monthly payments. It's repaid upon selling the home, moving, or passing away, though it may reduce inheritance and involve higher fees.
A Home Equity Loan Is a Lot to Consider
After assessing all your options, it’s clear a home equity loan on a paid-off house can be a viable possibility for homeowners seeking financing.
By understanding the borrowing options available, carefully evaluating your needs, and shopping around for the best home equity products, you can make a smart move that aligns with your financial goals.