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Yes, homeowners with paid-off properties who are interested in accessing home equity to pay for home improvements, debt consolidation, tuition or home repairs can leverage their equity through many of the same tools that mortgage-holding homeowners use. This includes home equity loans, HELOCs and cash-out refinances. We cover what's unique about the process for obtaining equity from a paid off home as well as things to keep in mind before applying for financing.
- Can I take out a home equity loan after I’ve paid off my mortgage?
- Can I take out a new mortgage on a paid-off home?
- Can I take out a HELOC on a paid-off home?
- Applying for a home equity loan after your home is paid off
- Why can't I get approved for a loan when my home is paid off?
- How much equity can I expect to cash out of my home?
- Things to consider before borrowing against your paid off home
Can I take out a home equity loan after I’ve paid off my mortgage?
Taking out a home equity loan on your paid-off house is an option to explore if your goal is to extract some cash for debt consolidation, home improvements or repairs.
A home equity loan might be a good option if you’re looking for a fixed monthly payment, single lump-sum distribution and fixed interest rate. However, home equity loans have closing fees ranging from 2-5% of the loan amount, which increases the overall cost of the loan.
The interest rate on home equity loans may be lower than on other debts over the long run, such as most credit cards. However, they're likely to still be more expensive than comparable purchase and refinance mortgages.
Can I take out a new mortgage on a paid-off home?
When you have a mortgage on your home and you want to get a new loan with better terms and pull out some cash, you might do what’s called a cash-out refinance. You get a new mortgage that’s larger than the balance on your current one, with the balance paid to you in a lump sum of cash.
Even when you have no mortgage on the property and just want to get a mortgage to pull the equity out as cash, it’s still referred to as a cash-out refinance.
However, the cash-out refinance could require a higher interest rate than a standard mortgage. This is in part because the lender has no way of knowing whether the cash taken out is being put back into the home. Closing costs may also be higher in a cash-out refinance than on an equity loan. In addition, if you borrow more than 80% of the equity in your home, your lender might require you to purchase private mortgage insurance (PMI) which only benefits the lender.
On the plus side, the fixed interest rates and monthly payments can make it easier to budget for this type of loan than a variable rate HELOC. Average interest rates on refinance mortgages are still generally lower than comparable home equity financing over the long run.
Can I take out a HELOC on a paid-off home?
Homeowners who want to secure an open line of credit that taps into their equity for unpredictable expenses that could pop up over the next 10 years might want to skip the loan and instead get an open-ended home equity line of credit (HELOC).
With a HELOC, you can vary the amount you take out of the line, instead of committing to borrowing a fixed loan amount. HELOCs may have lower costs and fees than other types of equity loans, but their interest rates are flexible, so borrowers can see their monthly payments rise or fall during the term of the loan. If you’re unsure how much money you’ll need to access over the next 10 years, a HELOC could be a good fit.
HELOCs can also offer higher loan amounts than other types of equity loans. However, if you end up borrowing more than 80% of your home’s value, leaving you with less than 20% equity, you may be required to purchase PMI for the benefit of the lender.
Applying for a home equity loan after your home is paid off
One of the things that makes a paid-off homeowner a great candidate for a home equity loan is how much equity they own. The full value of their home represents their equity, rather than the difference between the mortgage and the appraised value, as is the case for most homeowners who still hold a mortgage.
Another point in the paid-off homeowner’s favor is that since there is no other lien against the property, the new loan takes the spot of primary lien and therefore is paid off first in the event of foreclosure. That makes the loan less risky from a lender’s perspective and often warrants a lower interest rate.
But that’s not all lenders are looking for when evaluating homeowners for loan approval. You still might find yourself denied for an equity loan even if you own the home free and clear. This can be due to other aspects of your financial profile.
Why can't I get approved for a loan when my home is paid off?
Having a paid-off home to secure your home equity loan may be an advantage, but it doesn’t mean you’re guaranteed a loan approval. Some of the factors that weigh into your loan being approved or declined include:
Ability to repay
Lenders are required to consider a borrower’s ability to repay a mortgage loan they take out. To determine your ability to repay, a lender may ask to see your recent tax returns and pay stubs.
Another factor in your approval is the ratio between your current income and your debt. Generally, lenders look for a DTI below 43% for home equity loans. If you’re carrying a lot of other debt, you might get denied.
Lenders look at your credit score as a means of determining the interest rate they’ll offer, but a score that’s too low can also result in a declined loan application.
While you may be able to get a HELOC with a credit line equal to 90% of your home’s equity, you might not be able to borrow more than 80% for a cash-out refinance or equity loan. The more you try to borrow, the higher the perceived risk in the lender's eyes.
How much equity can I expect to cash out of my home?
A paid off home might be all equity, but that doesn’t mean you can take the full assessed value of the home out. The amount you can borrow will be capped at your lender's max permitted loan-to-value ratio.
The loan-to-value ratio (LTV) is the percentage of your home’s appraised value that’s loaned out. So, if a lender caps their LTV at 80% and your paid-off home has an appraised value of $250,000, then your maximum loan amount would be $200,000. Home equity loans are generally capped at 85% LTV, while HELOCs can go as high as 90% LTV. Cash-out refinances typically go as high as 80% LTV. However you may be able to find 100% financing with certain VA lenders and specialty financing companies.
If you borrow more than 80% of your home’s value, you may be required to buy private mortgage insurance (PMI), which will further increase your monthly expenses to your detriment with no offsetting benefit.
Things to consider before borrowing against your paid off home
When you take out a loan on a paid-off home, you introduce some financial risks into your life that you may not have had before. This includes the risk of foreclosure if you’re unable to make your mortgage payments. Before you put your home on the line, you might want to ask yourself some of the following questions:
Is there another option?
There are other ways to get cash you might need to consolidate debt or pay for home improvements. Such options include personal loans and lines of credit. Unlike a home equity loan or mortgage, these won't risk foreclosure on your home if you're unable to pay them back.
Will the loan increase my overall wealth?
If the equity loan gives you money to use to increase your home’s value, it might be worth taking on the added risks. If the loan is for something else, like a big-ticket purchase or vacation, you should evaluate whether that expense justifies the risk. Generally productive expenses like substantial home improvements, education and renovations fall under the category of productive spending as they have the potential to increase your wealth. Car purchases, vacations and weddings serve are non-productive expenses that sap at your ability to generate long-term investment returns on your home.
Are the payment terms reasonable?
Many people don’t pay off their homes until they are close to retirement— which is not a time when people traditionally want to take on new long-term debt. Take some time to gauge your expected income, expenses and savings that you have on hand to cover emergencies. Taking out financing against your paid off home creates a new monthly payment that did not otherwise need to exist. Make sure you have ample capacity to meet these payments going forward for an extended period of time.