What's the Best Way to Tap Into Your Home Equity? Get a second mortgage, a reverse mortgage, or enter into an equity sharing agreement?
If you're a homeowner, you may be able to tap into your home equity to get cash for major expenses, such as home improvement projects, medical bills, or college tuition. But how you access your home equity can make a big difference in how much money you end up with—and what, if any, tax implications there are.
Here's a look at three common ways to tap into your home equity: taking out a second mortgage, getting a reverse mortgage, or entering into an equity sharing agreement.
With a second mortgage, you borrow against the equity you've already built up in your home. The equity is the portion of your home's value that you own outright, free and clear of any other loans.
For example, let's say your home is worth $200,000 and you still owe $100,000 on your first mortgage. That means you have $100,000 in equity. If you take out a second mortgage for $50,000, you'll have a total of $150,000 in debt on your home.
second mortgages typically come with shorter repayment terms than first mortgages—usually five to 15 years. That means the payments will be higher than they would be on a first mortgage, but you'll pay off the loan more quickly. And because the loan is for a smaller amount than your first mortgage, the interest rate is usually higher as well.
With a reverse mortgage, you borrow against the equity in your home and don't have to make any repayments until you die or move out of the home. That can be a good option if you're retired and need extra income to cover expenses, but it's important to understand how reverse mortgages work before you sign on the dotted line.
First, you should know that a reverse mortgage will impact your ability to leave your home to your heirs. That's because the loan balance—including interest and fees—will need to be paid off when you die or sell the house. If your home's value has gone up over time, your heirs may still be able to sell the house and use the proceeds to pay off the loan. But if the value of the home has gone down, they may end up owing money to the lender.
Another thing to keep in mind is that a reverse mortgage will affect your eligibility for Medicaid. That's because the money you receive from a reverse mortgage is considered income for Medicaid purposes. So if you're counting on Medicaid to help pay for long-term care in your later years, a reverse mortgage could make you ineligible.
Equity Sharing Agreement
With an equity sharing agreement, you team up with another person—usually, but not always, a family member—to buy a home. The two of you will share ownership of the home, and when you sell it, you'll split the profits (or losses) according to the terms of the agreement.
One advantage of an equity sharing agreement is that it can help you buy a home that you couldn't afford on your own. But there are potential risks as well. For example, what happens if your partner stops making their share of the mortgage payments? And what if you want to sell the house but your partner isn't ready? It's important to have a lawyer draw up an ironclad agreement that covers all the potential contingencies before you sign on the dotted line.
The Bottom Line
Before you tap into your home equity, it's important to understand the pros and cons of each option. Weigh the risks and potential rewards carefully before making a decision, and make sure you understand all the tax implications as well.