A paid-off house is an amazing accomplishment. When you fully own your home, you no longer have to worry about monthly mortgage payments and can put the extra money toward other areas of your life.
But perhaps you need to fund other projects like home improvements, college for your kids, or a new car. That may lead you to ask whether or not you can get a mortgage on a house you already own.
The answer is yes. Generally speaking, however, there are some considerations you should make and options to weigh. We’ll talk about what loan options you have if you own your house outright, the advantages/disadvantages of each choice, and anything else you should know before taking action.
Is It Possible to Get a Mortgage on A Home I Own?
If you’ve paid off your existing mortgage, you can still use its equity to help get another loan. We’ll talk about the types of loans that may be available to you later.
There are certain qualifications that you must meet depending on the loan that you receive. Certain things like having good credit and a solid history of credit will greatly improve your chances of getting approved for a loan and getting a good rate.
Lenders typically are more willing to work with you if you’ve paid off your current mortgage.
Why your Chances of Getting a Loan are Better with a Paid off Mortgage
One of the key factors that lenders look at when they consider your loan application is your loan-to-value ratio (LTV). This is the total amount of loans that are against your home as compared to its current value.
The LTV is a major factor in whether or not you qualify for certain types of loans and what you can borrow. A lower LTV for most lenders means that you’re a lower risk.
A low LTV will make it more likely that you’ll qualify for a loan.
If you’ve paid off your home, that means you’ve paid off the entire loan balance. Lenders look at this favorably.
Additionally, lenders typically allow you to borrow 80 to 85% of your home’s value. This amount is after any mortgage balance on the home.
A paid-off house doesn’t have an existing balance to worry about. Hence it’s possible to borrow up to 85% of your home’s total value with certain loans.
What Loans Can I Get On A Paid Off House?
Your options include a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. Let’s dive deep into each of these loan types.
Home Equity Loan
Home equity loans allow you to borrow against the equity of your home. Also known as a second mortgage, it’s a type of consumer debt.
The loan amount on a home equity loan is the difference between the home’s current market value and the mortgage balance.
The interest rate on home equity loans are typically fixed rates. This means that the interest rate on the loan never fluctuates over the life of the loan.
The minimum credit score for this type of loan is usually between 620 and 700.
How Home Equity Loans Work
Home equity loans are almost like a mortgage. The home’s equity is used as collateral on the loan. You can borrow as much as 85% of your home’s appraised value.
The repayment term is similar to what you find on a traditional mortgage. You make fixed, monthly payments that cover the principal and interest.
Just like a mortgage, if you fail to repay the loan, lenders can sell the home to pay off the remaining debt.
Advantages of A Home Equity Loan
If you have a stable income, a home equity loan is a good choice to access cash. The interest rate on these loans is similar to your first mortgage.
Interest rates on other loan options like credit cards and other consumer loans are typically much higher. In fact, many borrowers use a home equity loan to pay off higher-interest debt like credit card balances.
It is an ideal choice for funding more expensive financial goals like paying for college, consolidating debt, and home improvements.
Disadvantages of A Home Equity Loan
The main problem with using a reverse mortgage loan is that it makes it all too easy to fall into a cycle of debt. You might be tempted to keep spending and borrowing in a perpetual cycle that increases your debt levels.
This scenario is known as reloading which means that you habitually take out loans to pay off existing debt, only to turn around and make more purchases.
Home Equity Line of Credit
Home equity lines are a type of home equity loan. With a home equity line of credit (HELOC), you can draw funds as needed.
The money is paid back with a variable interest rate. It is secured by your home.
Paying off large expenses or consolidating higher-interest debt are good uses for HELOCs.
How A Home Equity Line of Credit Works
Your home is the collateral that the loan is backed by. A HELOC works similarly to how a credit card does in the way that the available credit works.
Basically, your credit line can be for as much as the available equity on your home. You can use as much as your available credit, replenishing it by paying back the outstanding balance.
This means you can borrow as much or as little as you need through the draw period. This draw period is usually around 10 years. Once the period ends, the repayment period begins and usually lasts around 20 years.
Advantages of A Home Equity Line of Credit
HELOCs have lower interest rates than other loan options like credit cards. That’s what makes them ideal for consolidating debt or funding ongoing projects.
The funds on a HELOC are available as you need them. With a personal loan, you have to take the money as a lump sum. That means you might have to take out additional personal loans in the future as you need more money. Otherwise, you have to ask for a larger amount and pay interest on that total amount.
The loan terms on a HELOC are very flexible. Terms are determined largely by how much you want to borrow and the lender you choose. However, a HELOC can last for as many as 30 years, providing you with a cushion in case you experience a sudden financial hardship.
If you use a HELOC towards home improvement projects, the money might be tax deductible. Check with an accountant before taking out a HELOC for a home project to review your situation.
Disadvantages of A Home Equity Line of Credit
HELOCs have variable interest rates in most cases. That means that your interest rate could go up or down, depending on market conditions. That leaves you with a higher risk of paying more interest and an increased monthly payment amount.
Similar to a second mortgage, HELOCs also put you at risk of overspending. During the draw period, you only make interest-only payments. Your monthly payments seem lower because of this. Your monthly payment goes up after this period, which can cause a huge shock to your wallet.
Cash Out Refinance
A cash-out refinance usually works by replacing an existing mortgage with a new mortgage that also allows you to borrow cash from the home’s equity. On a home that you’ve paid off, the majority of the money will come as a lump sum of cash.
Cash-out refinancing loans have a fixed interest rate.
You can typically borrow as much as 80% of your home’s value with this option. A cash-out refinance requires a home appraisal to determine its market value.
Similar to a mortgage, you also must pay closing costs. This amount is typically between 2 to 5% of your loan balance. So you’ll want to have enough savings to cover closing costs.
Some mortgage lenders will cover a portion of the closing costs if you to a higher interest rate. Another option is to roll the closing costs into the loan balance.
Your minimum credit score for most lenders is at least 620. If you want the best mortgage rates, you’ll need a score of 720 or more.
How Does A Cash-Out Refinance Work
With a typical cash-out refinance loan, you get a new loan for your current mortgage that’s for a higher amount than the original mortgage. That extra cash is the “cash out” portion. It’s determined by how much equity you have in your home.
When you do a cash-out refinance on a home without a mortgage, you must still have an appraisal completed on your home. Lenders typically want you to retain at least 20% equity on your home.
The rest of the equity is available for you to borrow towards other financial goals.
Advantages of A Cash-Out Refinance
The interest rate is lower than other types of loans since it’s backed by your home. The exception might be your last mortgage if rates were lower at that time.
A cash-out refinance makes sense when you need access to more funding to make a large purchase. The amount you can borrow on other options like credit cards is more limited.
It’s also a great option to use to consolidate your existing debt.
Disadvantages of A Cash-Out Refinance
The process of getting cash out is similar to that of getting a mortgage. It will take weeks to jump through all the hoops. As a result, a cash-out isn’t a great option if you need a loan fast.
There are also extra costs associated with this loan. You must pay closing costs that are between 2% to 5% of the loan, which can get expensive.
What to Consider Before Getting A Mortgage On the House You Already Own
Before you even start comparing loans, it is important to think about the reasons why you should or shouldn’t use your home’s equity to get a new loan. Some considerations you should think about include:
- What will I use the money for? Will that money help increase my current home’s value, reduce debt, or help me with another important financial goal?
- Can I afford the payment? Make sure your monthly budget can handle the payments on the new loan. Taking out another mortgage should have little effect on your ability to save or reach your financial goals.
- Will I qualify for good rates? Your credit score, debt-to-income ratio, and credit history are all big factors that determine your rate. If there is some improvement in these aspects, consider whether you can work on improving your credit score, etc. before taking out a loan.
- How much do I need? The amount of money you need to borrow will determine how much your payments are.
