Best Way To Take Equity Out of Your House

One of the most frustrating things during my years as a financial planner was the number of people who insisted on paying their mortgage off early or adding extra principal to their mortgage payments and then, years later (or not) wanting to know the best way to take equity out of your house.

Grrrr!!!

If you’re not going to listen to me about the best place to invest extra money, or if you ended up with a ton of equity in your home thanks to rising home prices, or just living there for a decade or more, then listen to me now about the best way to take money out of your home equity.

Take Money Out of Your Home’s Equity by Refinancing

Usually, taking money out of your home equity by refinancing is dumb. However, with interest rates at historical lows, and lenders competing with each other, it is possible to take equity out of your home, lower your interest rate, and pay lower expenses, all without sticking you with a big loan that you have to pay back.

Here is how it works.

Let’s say you owe $300,000 on a house worth $500,000. You have $200,000 in equity.

The most common way to get cash from that equity is via a home equity loan, or home equity line of credit. The problem with both of those solutions is that they are loans that you have to pay back. Sure, you get $100,000 (or whatever) but now you have an added monthly expense for paying that loan back in the form of a $300 a month payment, for example.

Here is where refinancing is so great. If you have something like a 4%, or higher, mortgage, you can refinance your home and get $100,000 free and clear with no extra payment.

This is how it works.

A refinance is basically where you take a new mortgage out from a different lender, and that lender uses the money from your new mortgage to pay off the old mortgage, and they give you whatever is left. This is sometimes called a cash out refinance because you are taking cash out of your refinancing proceeds.

So, in the above example, you could refinance your home with a $400,000 mortgage and walk away with $100,000.

There is no extra loan to pay off, just your mortgage. In some cases, your mortgage payment might go up, but if your interest rate was higher when you started, and your original mortgage was close to $400,000, you might not even notice the difference in monthly payments. Either way, it’s going to be a lot less than the payment for paying back an equity loan because the repayment period is 30 years, and the interest rate is lower. (Don’t come at me with your “spreadsheet net worth” baloney. This is real life we are talking about here.)

When Refinancing to Get Equity is Bad

If you’re reading this article in the future and I haven’t updated it yet, there are some times when refinancing is a bad idea.

You almost never want to refinance your mortgage into a higher interest rate. So, if you lock in a sweet 3% interest rate in the zero percent Federal Reserve Rate times, you do NOT want to refinance into a 5% mortgage, or 6% mortgage. That same 30-year period that helped you out above kicks you in the teeth if you are getting a higher rate. Not only will your payment be higher, but you will pay a lot more over the term of the loan as well.

Check out these reviews of personal finance apps like Digit, Acorns, and Grifin.

Also, the closing costs on refinancing often make it a bad deal compared to a home equity loan or home equity line of credit (HELOC). However, these days, closing costs are relatively low these days, especially if you shop around, because there is solid competition among banks and lenders now that not everyone is rushing to refinance their mortgage. That means lower closing costs for you.

Tips To Avoid a Bad Refinance

• Never refinance into paying mortgage insurance – Keep the equity inside your mortgage at 20% – If you can’t use a HELOC or HEL instead.
• Don’t refinance to a higher interest rate
• Don’t refinance without comparison shopping. Sure, that ad from your bank looks great but it might not be the best.
• Don’t refinance without understanding ALL the closing costs, even the ones they say can’t be known. Get estimates if they vary.
• Don’t refinance if you will be selling your house soon

If you are selling your house in the near future, don’t refinance. There is no rule that says you have to put all of your equity into the purchase of your next house — unless you NEED all your equity in order to purchase your next house.

If you have a house worth $500,000, you owe $300,000 and are buying a house worth $600,000, you could just put 20% down on the next house ($32,000) and keep $168,000. Obviously, you should play around with what works best for you. Putting more down will lower your payment, for example. Use one of the many online mortgage calculators to choose the right combination of payment, and cash that you want and tell your lender to make it happen.

Advanced Personal Finance Tricks

Check out the advanced refinance trick for the financially well off that we detailed here you are doing well financially toward achieving financial independence.