If you want to tap into your home’s equity, you have a few options, one of which is the closed-end home equity loan. A closed-end home equity loan is like your standard mortgage with monthly payments and a finite term.
Keep reading to learn how it works.
How the Closed-End Home Equity Loan Works
The closed-end home equity loan gives you the chance to tap into your home’s equity. Let’s say you borrow $100,000 of your home’s equity with a closed-end loan. You would receive that $100,000 at the closing. You would then start making principal and interest payments every month for the chosen term.
The closed-end home equity loan typically has a loan term of up to 20 years. The actual term varies by lender. The interest rate on the closed-end home equity loan is typically fixed, which means it doesn’t change for the life of the loan.
Your home is the collateral for the closed-end home equity loan. It takes the second lien position, though. The first lien position remains with the first mortgage lender. This means if you default on the loan and you go into foreclosure, the first lienholder gets paid first. The second lienholder receives the remaining funds (if any).
The Home Equity Line of Credit Difference
The closed-end home equity loan is just one way that you can tap into your home equity. You can also use the home equity line of credit.
The home equity line of credit is another second mortgage. You borrow a line of credit, like a credit card, though. You don’t receive a lump sum amount at the closing. Instead, you receive access to your line of credit, typically sitting in a checking account. You can then draw the funds, as you need them.
The difference with the home equity line of credit is that you only make payments on the money you withdraw. If you have a line of credit of $100,000, but only withdraw $10,000, you make payments on the $10,000. For the first 10 years of the HELOC, you only have to pay interest every month. It isn’t until the end of the first 10 years that you pay principal and interest on the amount you withdrew. You typically make principal and interest payments for 20 years.
The final difference in the home equity line of credit is the ability to reuse the funds. It works just like a credit card. You withdraw the funds that you need. If you repay those funds, including the principal, you can reuse them during the draw period, which is the first 10 years of the loan. Once the draw period ends, you cannot withdraw funds any longer, though.
The Cash-Out Refinance
Your final option to tap into your home’s equity is the cash-out refinance. This is a first mortgage program. It requires you to refinance your first mortgage and take a larger amount than you currently owe.
If you have a great interest rate or term on your first mortgage, you may not want to choose this option. If you don’t love your interest rate or term, though, it can be a great way to refinance and tap into your home’s equity.
The cash-out refinance works much like the closed-end home equity loan. You receive the ‘extra’ funds that you borrow in one lump sum. You then make principal and interest payments on the full amount (the amount of your original first mortgage plus any equity you borrowed).
The cash-out refinance is a first lien product, though. This means that if you default, the lender gets first dibs on the proceeds of the sale of the home. This typically means you can secure a lower interest rate than you could on a home equity loan or HELOC because they are both second liens.
The closed-end home equity loan is good for those that know exactly the amount of money they need for their project, debt consolidation, or other expenses. If you have variable expenses or your home renovations are drawn out, you may want to choose the home equity line of credit for a little more flexibility.