As a homeowner, you’ve built up your home equity and have the right to use it as an asset—but the question is, should you? Real estate equity is grown by making ongoing mortgage payments to your mortgage lender, improving and maintaining your property, and taking advantage of appreciation as your property value grows over time.
It can be a valuable part of a long-term wealth-building or retirement plan, but you can also exchange equity for cash during a remortgage.
A general rule of thumb is to never leverage your equity to pay for general living costs or entertainment. Barring those uses, let’s take a look at how remortgaging for equity works, whether it’s right for your needs, and what alternatives to consider.
How Does Remortgaging to Release Equity Work?
Remortgaging to release equity is done with a cash-out remortgage. This equity release transaction provides you with a new and larger mortgage loan that pays off the remainder of your current mortgage, plus supplies you with an additional cash sum.
The amount of cash you can receive is usually limited to 80% of your equity at the time of sale, or with government-backed loans, 85% limit for FHA and 100% for VA cash-out refinancing.1
Pros of Remortgaging to Release Equity
Using your equity wisely can yield positive results for your family and future. A cash-out refinance can help you:
- Free up funds for wealth-building opportunities or investments
- Generate overall savings if money is used to pay down high-interest debt
- Maintain a single loan and monthly payment instead of multiple mortgages or debts
- Rebuild your equity by increasing home value if cash is used for property renovations or home improvement
- Avoid higher-interest unsecured debt to meet financial obligations
Cons of Remortgaging to Release Equity
Taking on new debt—even if it’s a replacement for current debt—can cost. Caution points include:
- A higher interest rate if interest rates are up from when you got your existing mortgage
- Paying closing costs, usually 2% – 6% of the loan total1
- Potential for a higher monthly payment with a larger loan
- Paying monthly mortgage insurance premiums if your equity falls below 20%
- Risk of foreclosure if you can’t meet repayment obligations
- Significantly reducing your equity as a growing asset
Alternatives to Remortgaging to Release Equity
How else can you make your trapped equity work for you? While borrowing against it is a common option, it’s not the only way.
Home Equity Loans
With a home equity loan, you can borrow against some of your available equity—usually limited to 75% or 80%, although some lenders will go as high as 90%.2
Home equity loans are also known as second mortgages, secured by a second lien on your property. This means that defaulting on the loan includes the risk of foreclosure.
Because this lender is second in line (after your primary mortgage lender) to recoup their costs, you’ll pay higher interest rates in a home equity loan than for a primary mortgage, albeit still lower than credit cards or unsecured loans.
A home equity line of credit, or HELOC, is similar to home equity loans, but instead of a set amount, you establish a revolving pool of funds similar to a credit card with a maximum limit.
You’ll have a window of time to borrow up to your total, during which you can opt to borrow all, some, or none of the amount available. Once the draw period ends, you’ll start repaying whatever you ended up using (though you may need to begin making small, interest-only payments during the draw period).
If you’re caught between a need to convert your total equity and the desire to stay put in your family home and don’t want to take on new debt, there’s another option to consider: a sale-leaseback (SLB).
With an SLB, you close a sale on your property with an investor and service provider, but unlike a traditional sale, you continue to live in your home. There are many sale-leaseback benefits. An SLB combines the sale with a unique lease agreement that:
- Guarantees your right to remain in your home as long as you like
- Locks in an agreed-upon monthly rent for up to five years with no increases
- Limits future rental increases—so you won’t ever be hit with unreasonable rent hikes
Plus, in addition to converting your full equity to cash through the sale, you’ll be able to reduce your monthly housing costs through no longer paying property tax, homeowner’s insurance, or covered home improvement repairs and maintenance.
Converting equity through an equity release option to pursue goals, build wealth, or help with urgent situations is a powerful part of every homeowner’s financial assets, but it comes with costs and risks. While a remortgage or new mortgage to release equity helps you avoid multiple loans and monthly payments, it’s not right for every situation. Consider all your alternatives to make the best use of your equity, including home equity loans and lines of credit as well as sale-leasebacks.
- Forbes. Cash-Out Refinance Calculator. https://www.forbes.com/advisor/mortgages/refinance/cash-out-refinance-calculator/
- The Motley Fool. HELOC Calculator: How Much Could You Borrow? https://www.fool.com/mortgages/heloc-calculator-how-much-could-you-borrow.aspx