You finally own your home free and clear. And now, you want to put that ownership stake to use. Is this even possible?
Fortunately, the answer is yes. You can take equity out of your home even after your mortgage is paid off. One of the easier ways to do so is to sell your home, but there are also financial products that allow you to extract equity from your paid-off home quickly without having to pick up and move.
Each has its pluses and minuses. So let’s look at the options.
Can you take equity out of a paid-off house?
“It is definitely possible to take equity out of your home after you’ve paid off a previous mortgage,” says Jeffrey Brown, branch manager with Axia Home Loans in Bellevue, Wash. “Assuming you qualify, you can access that equity at any time.”
Actually, those means of access are pretty much the same for a paid-off house as for one that still has a mortgage on it. You can take equity out of your home using one of these tools:
- home equity loan
- home equity line of credit (HELOC)
- reverse mortgage
- cash-out refinance
- shared equity investment
When should you tap equity on a paid-off house?
Why would anyone pursue fresh financing after finally paying off a mortgage? Well, why not? Your home is an asset, and you can make it work for you. And when you own it free and clear, its tappable potential is at its greatest (see Pros, below).
Viable reasons abound for borrowing against your ownership stake, from funding a major home improvement project to investing in a business to purchasing more property. Or, frankly, for whatever you need. However, since your home will serve as the collateral for the debt, you should be judicious in how you tap it. Two good rules to follow: Use your equity in ways that improve your finances or work as an investment and don’t take out more than you can afford to lose.
How to get equity out of a paid-off house
Cash-out refinance on a paid-off home
Let’s say you were still paying off your mortgage, had adequate equity and needed cash. You’d likely do a cash-out refinance, which typically has a relatively lower interest rate compared to other types of loans.
You can do the same now, even though you’ve paid off your mortgage. You’ll simply take out a new mortgage and pocket the equity in the form of cash at closing. As with any refinance, however, you’ll be on the hook for closing costs, which can run 2 percent to 5 percent of the amount you’re borrowing and any escrow payments.
“A cash-out refinance generally results in the lowest interest rate and offers the highest loan amounts you can borrow,” says Matt Hackett, operations manager for Equity Now, a mortgage lender headquartered in Mamaroneck, New York. “It can be a fixed- or adjustable-rate loan, and it is fairly straightforward to apply and qualify for.”
Home equity loan on a paid-off home
Alternatively, you could apply for a house-paid-off home equity loan.
Like a cash-out refinance, a home equity loan is secured by your property (the collateral for the loan) and enables you to extract a large amount of equity because you have no other debt attached to the residence. You’ll also likely need to pay closing costs, and as with any mortgage, you risk losing your home if you can’t pay it back.
The upsides: Home equity loans typically come with fixed interest rates, which are usually much lower than personal loan rates. Plus, if you use the money on home improvements, you can deduct the interest on your taxes.
HELOC on a paid-off home
Many homeowners like the flexibility of a home equity line of credit (HELOC), which works more like a credit card you can use when you need it.
“HELOCs come with adjustable interest rates, often based on the prime rate,” says Hackett. “They offer the opportunity to draw funds and pay back funds during the initial draw period, which is more flexible than a standard first mortgage.”
What’s more, you’re only responsible for repaying the amount you use versus the fixed obligation of a cash-out refinance or home equity loan, says Vikram Gupta, executive vice president and head of home equity for PNC Bank.
Do read the fine print of your agreement, though. “Additionally, some HELOCs may have various fees associated with them such as annual fees, early closure fees, and origination fees, so borrowers should pay close attention to these when evaluating their total financing costs,” says Gupta.
On the downside: HELOCs aren’t as easily attainable — you need a strong credit score — and, given their fluctuating interest rates, can mean variable monthly repayments.
Reverse mortgage on a paid-off home
If you’re 62 or older, you could be eligible for a reverse mortgage. This financing vehicle gets you regular payments from a mortgage lender in exchange for your home’s equity.
“A reverse mortgage can be a great way for seniors to access the equity in their homes to pay for monthly living expenses and keep them living independently, especially if they don’t have monthly income in retirement,” says Brown.
Reverse mortgages have pros and cons, though. You’ll still need to keep up with homeowners insurance, property tax and HOA dues payments to avoid foreclosure, and there’s a limit to how much money you can get. You can’t let the home fall into disrepair either — you’ll still be responsible for maintenance.
Most of all: “It’s important for the borrower’s survivors to understand that the entire [reverse mortgage] balance, plus interest and fees, is due if the borrower passes away,” says Gupta. “The borrower’s house may need to be sold if their estate cannot repay the reverse mortgage loan.”
Shared equity agreement on a paid-off home
With a shared equity agreement — a relatively new method of liquidating equity — you’ll sell a portion of your future home equity in exchange for a one-time cash payment.
“The details on how this works and what it costs will vary from investor to investor,” says Andrew Latham, CFP, CPFC, content director and managing editor for SuperMoney.com. “Let’s say you have a property worth $600,000 with $200,000 in equity built up. A home equity investor might offer you $100,000 for a 25 percent share in the appreciation of your home.”
If your home’s value increases to $1 million after 10 years — the typical term for a home equity investment — you’d have to return the $100,000 investment plus 25 percent of the appreciation, which in this case would be $100,000. You’d also need to return the investment plus the share of appreciation if you sell the home.
“The advantage here is that you can tap into your home’s equity without getting into debt,” says Latham, “and there are no monthly payments, which is a great plus for homeowners struggling with cash flow.”
In effect, you’ll have a silent partner in your home, so you’ll need to be comfortable with that and the rights that partner has to protect their investment.
Pros of tapping equity on a paid-off house
Easier to get approved
On the plus side, it can be relatively easy to qualify for a home equity loan on a paid-off house since you already have a solid track record of paying off your first mortgage, which likely means you’re older and have good credit and possibly a higher income. This ups your creditworthiness as a borrower, making you a preferred candidate to lenders and lowering the interest rate you’ll pay.
You also won’t have to worry about the size of your ownership stake or loan-to-value ratio — two other criteria that lenders look at, and that affect how much you’re able to borrow.
No-strings money
Furthermore, you can use your equity for any reason. Most lenders won’t care, for instance, if the money will be put toward funding retirement, seeding a new business or making a down payment on an investment property.
“Many seek to pay for their children’s educational expenses, fund their retirement or pay for an unexpected medical emergency like cancer care for a loved one,” says Kelly McCann, an attorney specializing in construction and real estate with Burnside Law Group in Portland, Ore.
Avoid capital gains taxes
In addition to being able to use the money for nearly any purpose and being more likely to qualify, tapping into your home equity also has the potential to save you money on your income tax.
“It may be smarter to tap into your equity than selling your home and downsizing,” says McCann. “If you have capital gains on your home of more than $250,000 (or more than $500,000 if you are a married couple) you must pay taxes on that gain after the sale of your home. However, if you borrow against your home by, for example, taking out a home equity loan, you don’t have to pay taxes on the loan proceeds — you get the money tax-free.”
Cons of tapping equity on a paid-off house
Risk of losing your home
Of course, if you choose a form of financing wherein your home is used as collateral, like a cash-out refinance or home equity loan, there’s always the risk that you could lose your home if you can’t repay.
Upfront expenses
While they often carry lower interest rates than unsecured loans, home equity products aren’t free. Most have upfront expenses and many of those good old closing costs that you remember all-too-well from your first mortgage. You’ll have to come up with the funds to pay for expenses like origination fees and a home appraisal, to name a few. The whole process could be paperwork-heavy and time-consuming, too.
Being frivolous with funds
You’ve got a tempting chunk of change there in your home. But you’ve worked long and hard to acquire this asset, so don’t blow it on one-time, discretionary expenses. Buying a car (a depreciating asset), paying for a wedding or taking a vacation — these are not-so-good reasons to deplete your equity stake.
How much equity am I able to cash out of my home if it’s fully paid off?
Even if your home mortgage has been paid in full, which means you have 100 percent equity, you cannot borrow all of that money. Generally, lenders allow for borrowing up to 80 to 85 percent of a home’s appraised value. That means if your home is worth $500,000 you may be able to access as much as $425,000 of that equity. However, the specific limit also varies by lender.
Bottom line on getting equity out of a paid-off home
Determining whether it makes sense to pull equity out of a house you’ve already paid off really comes down to your unique circumstances and financial picture, as well as your short- and long-term goals. It’s also important to consider whether you’d be able to make the payments on the loan if your financial circumstances were to change unexpectedly.
“Homeowners should ask themselves: ‘What is the purpose of the funds needed?’ They also need to assess their individual financial situations to ensure they have the cash flow to pay off the loan in the future, particularly as they approach retirement,” says Gupta.
If you decide to proceed, make sure to practice the due diligence you would apply to any other financial transaction—shop around with several lenders and find the best terms for your needs.
FAQs
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A home equity line of credit, or HELOC, is typically the most inexpensive way to tap into your home’s equity. When opening a HELOC, you only pay interest on the money you actually use. As an added bonus, when using a HELOC, you won’t pay all the closing costs that come with a home equity loan or a cash-out refinance on a paid off home.
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Lenders typically look for credit scores of at least 620 on home equity loan applications. You’ll qualify for an even better rate with a score of 700 or above.
A home equity line of credit (HELOC) on an investment property is a loan taken out against a piece of real estate that you use to earn income or a financial return. So, instead of taking out a HELOC on the property where you actually reside, a HELOC on an investment property leverages a place where you do not live as collateral to borrow money.
While many borrowers have been interested in HELOCs over the past two years, HELOCs on investment properties aren’t nearly as common — or as easy to get. The vast majority of HELOCs are taken out against primary residences; lenders are more comfortable with a loan against the actual roof over your head because they know you’ll prioritize repaying that loan.
However, some lenders do offer HELOCs on investment properties. Here’s how they work, and how to decide if they’re a good strategy for your financing needs.
How do you get a HELOC on an investment property?
Getting a HELOC is similar to getting a mortgage (in fact, HELOCs are a type of second mortgage). Here’s how the application process works.
1. Know your finances.
Before you apply for a home equity line of credit, you’re going to want to estimate how much equity you have. Property values have continued rising this year – albeit more slowly than they had been during the peak of the pandemic – so you’ll want to get a sense of what your property is worth versus how much, if any, you have left to pay on the first mortgage. The difference between how much you owe and the investment property’s fair market value equals, roughly, the amount of your equity stake. In ascertaining the value, you might want to consult a real estate professional who specializes in similar properties to issue a broker price opinion on yours.
2. Shop around to find the best deal.
Shopping around for a HELOC on an investment property is going to be more limited than for the regular, residence-based variety: There simply aren’t as many lenders that offer these lines of credit. Still, there are always choices, and it’s always important to compare. Try to find at least three lenders, and try to suss out how practiced they are in this sort of HELOC. Look at the APR that each lender offers, and be sure to scrutinize the fine print to understand whether there are additional fees such as a penalty for closing the line of credit early.
3. Apply.
When you’re ready to officially apply for a HELOC, be prepared for the kind of complete under-the-hood type of financial scrutiny you would receive with any type of request to borrow a sizable chunk of money. A lender will look at your credit score, your debt load, your cash flow, your cash reserves and every other detail about your finances to determine a) whether they will loan you the cash and b) how much they’re going to charge you to borrow it. The lender will also probably do an appraisal of your property, which sets the official value on it. In determining its worth, they’ll look at its condition and also the amount and sort of income it generates.
4. Close.
Closing on a HELOC is typically a much faster process than closing on a traditional mortgage. Some lenders will close in as little as three days, and you can access the cash within a week.
What are the pros and cons of getting a HELOC on an investment property?
Pros
- Cheaper than many other forms of borrowing: The interest rates on HELOCs are often lower compared to other forms of financing like credit cards and personal loans. (You’ll likely pay a bit more because it’s tied to an investment property, however — more on that below.) A HELOC might also be simpler and cheaper to obtain than a business or commercial property loan.
- Less risk for you: Taking out a HELOC on an investment property might feel a bit safer than a HELOC on your primary residence. If you default on the line of credit, at least the home you live in won’t be subject to foreclosure.
- A flexible way to access cash: You can continually draw from the HELOC during the initial draw period, so it’s often a good fit for fluctuating or longer-term expenses like renovation projects.
- Cheap initial payments: With most HELOCs, you only need to pay interest during the draw period. Paying back the principal starts during the repayment period.
Cons
- Limited availability: Not many lenders offer HELOCs on investment properties.
- Higher rates: An investment property is inherently riskier than a primary residence: You don’t live in it, which means you aren’t as impacted if you lose it. That means that lenders charge higher rates for any type of financing attached to one, including a HELOC. For example, at this writing,TD Bank’s lowest available APR on HELOCs for investment properties is more than 1 percentage point higher than a HELOC on a primary or secondary home.
- Extra fees: Most HELOCs come with an annual fee and an early cancellation or termination fee if you close the line within the first two or three years.
- Negative equity concerns: Real estate doesn’t always appreciate, and if your property loses value, you could wind up underwater (owing more on a property than it’s worth).
HELOC requirements for investment properties vs. primary residences
| Investment properties | Primary residences | |
|---|---|---|
| Credit score minimum | Generally 700 | 650-680 |
| Debt-to-income (DTI) maximum | 43% (can depend on anticipated rental income) | 43% to 50% |
| Loan-to-value (LTV) maximum | 80% | 85% |
When is it a good idea to use a HELOC on an investment property?
Using a HELOC on an investment property can be an easy way to access cash that will generate a return. For example, you might use the funds from the HELOC to buy another property that can act as an additional investment, without depleting your savings. Or you might use the funds to upgrade or expand your property, making it more attractive to prospective tenants and enhancing its revenue stream. HELOCs are an especially good idea when you want to use the funds on the real estate itself — especially because there are tax benefits (see below).
Are you able to deduct a HELOC on your taxes?
Tax advantages are one of the pluses of HELOCs. You might be able to deduct the interest paid on a HELOC, including a HELOC on an investment property, so long as the funds were used to build, improve or repair the real estate backing the loan in some way. Remodeling the premises, upgrading the HVAC system, constructing a new wing, or even buying an adjacent lot could all count as tax-deductible improvements.
You can’t deduct all of the interest, however. With HELOCs, you can only deduct the interest actually accrued on withdrawn funds (not on your total line of credit). Depending on your filing status, overall you can deduct up to $750,000 (if married filing jointly) or $375,000 (single or filing separately) of interest on combined debt, including any mortgages on your primary residence. You must also itemize deductions on your tax return.
What are the alternatives to using a HELOC on an investment property?
- Cash-out refinance: With a cash-out refinance, you’ll refinance the loan on your investment property to a higher amount — provided you have enough equity — and take the difference in cash. Some savvy real estate investors use this method to continuously add new properties to their portfolio mix. However, this strategy might not work as well today, with mortgage interest rates having gone up.
- HELOC on your home: If you can’t find a lender willing to extend a line of credit on your investment property, you might want to consider taking out a HELOC on your primary residence. This means your home is on the line, however, if you can’t repay what you borrow. You might not be able to get as sizable a loan, however, and you won’t be able to deduct any interest (because the loan’s backed by your home, not the investment property).
- Personal loan: Depending on your debt load, you might be able to take out an unsecured personal loan as a lump sum. The interest rates on these can be much higher if your credit isn’t the best, however, and you’ll need to start repaying what you borrowed right away.
- Small business loan: If you have set up a company to own/operate your investment property, consider comparing small business loans or line of credit to access the funds you need. The interest rates on these loans will likely be higher than that of a personal HELOC, and you’ll have to start full repayments right away or make more frequent payments (in the case of the line of credit). But if you have a solid business plan you can show to a lender that documents your strategy for expanding your real estate investment portfolio, this can be another viable option.
The bottom line on using a HELOC on an investment property
Opening a HELOC on an investment property can be a savvy financial move, particularly if your need for funds is real estate–related. You can leverage the property to improve the property — and its income-generating or appreciation potential. Plus, you may be able to score some tax benefits.
However, a HELOC on an investment property isn’t all upside: Rates are higher than some other types of financing — including residential-property HELOCs — and you need to have pretty solid financials. Also, the availability is limited to a small number of lenders.