Owning a home provides you with much more than a roof over your head. Your home is a versatile asset, a kind of financial Swiss Army knife that can be used to help fund a college education or to pay down an onerous credit-card debt, for example, or to provide a steady income stream, or as an investment that adds diversity, growth potential and tangibility to an asset portfolio.
Here are several ways to tap the value of your home:
A mortgage refinance. Refinancing a mortgage essentially entails moving out of an existing mortgage loan to a new loan, a transaction that typically comes at a cost to the homeowner – 2-3% of the overall amount borrowed is a good rule of thumb, although costs can range higher or lower.
Given the potential long-term financial implications, the decision whether to refinance should come only after carefully considering the costs, benefits, risks and tax ramifications. A financial professional can help you weigh those factors to come to a decision that’s in your best interests. To find a Certified Financial Planner in your area, check out the searchable national database at www.PlannerSearch.org.
Many refinancing transactions occur because the homeowner wants to access a lower mortgage rate. In most cases, the homeowner (in consultation with a trusted financial professional) deems it worthwhile to take on the cost of the refinance in order to lower their monthly mortgage payment or to shorten the term (length) of the loan, such as from 30 to 15 years.
If prevailing mortgage rates are lower than the rate you’re currently paying, it may make sense to refinance, provided that you can recoup the cost of the refinance over time. Lowering the monthly mortgage payment could also free up additional funds for other purposes, such as to invest toward retirement or a college education. Shortening the term of the mortgage may result in a higher monthly payment, but it enables the homeowner to get out from under the debt quicker.
On the other hand, refinancing might not make sense if it means the homeowner will assume a longer mortgage term, or if the homeowner expects to sell the residence within a few years.
If refinancing is believed to be a financially sound step for you, shop around to find the most favorable terms and other costs involved in the transaction. If you have an existing relationship with a bank or credit union, that relationship may yield a discount on the rate or on closing costs. Otherwise, sites such as www.bankrate.com and www.lendingtree.com post current mortgage-refinance rates from lenders across the country.
A home equity line of credit (HELOC). A HELOC is another way to tap the equity you’ve built in your home. In this case, a lender provides a line of credit tied to the appreciated value of the home. The homeowner can then use this line of credit when and how they want (subject to certain terms specified by the lender), as long as they repay any amount they use, plus interest.
Here’s an example of when it’s wise to use a home equity line of credit: Say the interest rate for the HELOC is 5% and you are carrying a credit-card balance with a 15% interest rate. Wouldn’t it make sense to take the HELOC funds, with its much lower borrowing cost, and apply them to pay down the high-interest credit card? The same logic applies if the HELOC funds are used to pay for a home remodel, where the added value to the home from the improvements could easily justify the cost of borrowing to fund the project.
Using your home as a rental property to generate income or purchasing a second home and renting it out for income. Either of these can be a viable option under the right circumstances. If you’re in a good enough position financially to either purchase a second home outright with cash or to take on a mortgage to buy it, and you’re willing to be a landlord for short- or long-term tenants, a rental property can provide a steady source of income and be an asset whose value could appreciate over time.
For people with flexibility, there’s also the option of turning your current home into a rental property, then moving into another home that you either buy or rent. Given the financial ramifications, as well as the many moving parts involved in these types of decisions, be sure to first seek guidance from a financial professional you trust.
Using a reverse mortgage for income later in life. Homeowners age 62 and older can convert the value of their home into income via a reverse mortgage, or HECM, short for Home Equity Conversion Mortgage. Essentially, the homeowner is borrowing against the equity in their home to obtain either a lump-sum payment or an income stream.
People who expect that they will lack adequate income to cover their needs in retirement, or who want to use funds from a reverse mortgage strategically as part of their retirement income and investing plan, may be solid candidates to at least consider a reverse mortgage. It’s wise to consult a financial professional well-versed in the pros and cons of this specific type of transaction before committing to go down that path.
JASON E. SIPERSTEIN, CFA, CFP, is the president of the Financial Planning Association of Rhode Island and president of Eliot Rose Wealth Management. He can be reached by email, at firstname.lastname@example.org.