Can you take out a home equity loan on a paid-off house?

Yes, you can take equity out of your home even after your mortgage is paid off. One of the easier ways to tap your equity is to sell your home. But there are also financial products that let you quickly extract equity from your paid-off home without having to move.

So let’s look at the options for getting equity out of a house you own outright.

Can you take equity out of a paid-off house?

“It is definitely possible to take equity out of your home after you’ve paid off a previous mortgage,” says Jeffrey Brown, a Seattle-based mortgage professional with NEXA Mortgage. “Assuming you qualify, you can access that equity at any time.”

Actually, those means of access are pretty much the same for a paid-off house as for one with a mortgage. You can take equity out of your home using one of these tools:

• Cash-out refinance
• Home equity loan
• Home equity line of credit (HELOC)
• Reverse mortgage
• Shared equity investment

How much equity can I cash out of my home if it’s fully paid off?

More than if you had a mortgage, that’s for sure. If the mortgage has been paid in full, you have 100 percent equity in your home.

However, even with a 100 percent stake, you cannot borrow all of that money. Generally, lenders allow for borrowing up to 80 to 85 percent of a home’s appraised value. That means if your home is worth $500,000, you may be able to access as much as $425,000 of that equity. Or even a bit more — some lenders allow up to 90 or even 95 percent, depending on the type of loan and your creditworthiness. But you’ll never be able to tap the entire value.

How to get equity out of a house you own outright

Cash-out refinance on a paid-off home

Best for: Homeowners who want to pay the least interest

Let’s say you were still paying off your mortgage, needed cash and had a sizable equity stake. You’d likely do a cash-out refinance, in which you’d swap your old mortgage for a bigger one, taking the extra amount — which is based on your equity stake — in cash.

You can do the same now, even though you’ve paid off your mortgage. You’ll simply take out a new mortgage and pocket the equity (essentially, the entire loan) in the form of cash at closing. In this case, the name’s a bit of a misnomer: It’s still called refinancing even though you won’t be paying off an existing mortgage. As with any refinance, however, you’ll be on the hook for closing costs, which can run 2 to 5 percent of the amount you’re borrowing and any escrow payments.

Home equity loan on a paid-off home

Best for: Homeowners who need a fixed sum and prefer predictable payments

Like a cash-out refinance, a home equity loan is secured by your property (the collateral for the loan). You’ll also likely need to pay closing costs, and as with any mortgage, you risk losing your home if you can’t pay it back.

The upsides: Home equity loans typically offer fixed interest rates that are usually much lower than personal loan rates. Plus, if you use the money on home improvements, you can deduct the interest on your taxes.

HELOC on a paid-off home

Best for: Homeowners who like flexibility in how much money they can take, and when they can take it

A home equity line of credit (HELOC) works like a giant credit card. HELOCs let you take out money during an initial draw period (which usually lasts 10 years). During that time, you’ll only need to repay the interest on what you’ve borrowed. After the draw period, you’ll enter the repayment period, which gives you 10 to 20 years to pay back the principal and any remaining interest.

What’s more, you’re only responsible for repaying the amount you use versus the fixed obligation of a cash-out refinance or home equity loan. Unlike those two, HELOCs have variable interest rates, which means your monthly payments will vary. However, you will owe interest only on the amount you actually withdraw, not on the entire credit line.

But to get a HELOC, you’ll need a strong credit score and sufficient income to handle fluctuating payments. Some HELOCs also carry various fees, including annual fees, early closure fees and origination fees — so pay special attention to the fine print when evaluating total financing costs.

Reverse mortgage on a paid-off home

Best for: Homeowners over the age of 62

If you’re 62 or older, you could be eligible for a reverse mortgage. This financing vehicle gets you regular payments from a mortgage lender in exchange for your home’s equity.

“A reverse mortgage can be a great way for seniors to access the equity in their homes to pay for monthly living expenses and keep them living independently, especially if they don’t have monthly income in retirement,” says Brown.

But reverse mortgages have pros and cons. You’ll still need to keep up with homeowners insurance, property taxes and HOA dues payments to avoid foreclosure, and there’s a limit to how much money you can get. You can’t let the home fall into disrepair, either — you’ll still be responsible for maintenance.

Above all, the borrower’s heirs must realize the entire reverse mortgage balance, including interest and fees, must be repaid when the borrower dies or moves out of the home. If the estate can’t cover the amount owed, selling the home may be necessary.

Shared equity agreement on a paid-off home

Best for: Homeowners who don’t qualify for traditional borrowing methods

With a shared equity agreement — a relatively new method of liquidating equity — you’ll sell a portion of your future home equity in exchange for a one-time cash payment.

“The details on how this works and what it costs will vary from investor to investor,” says Andrew Latham, CFP, and content director for SuperMoney.com. “Let’s say you have a property worth $600,000 with $200,000 in equity built up. A home equity investor might offer you $100,000 for a 25 percent share in the appreciation of your home.”

If your home’s value increases to $1 million after 10 years — the typical term for one of these home equity investment contracts — you’d have to return the $100,000 investment plus 25 percent of the appreciation, which in this case would be another $100,000. You’d also need to return the investment plus the share of appreciation if you sell the home.

“The advantage here is that you can access your home’s equity with no monthly payments required, making it an excellent option for homeowners who want to tap into their home’s value but don’t have the cash flow to qualify for traditional home equity financing products,” says Latham.

In effect, you’ll have a silent partner in your home, so you’ll need to be comfortable with that and the rights that partner has to protect their investment.

Why should you tap equity on a paid-off house?

Why would anyone pursue fresh financing after finally paying off a mortgage? Well, why not? Your home is an asset, and you can make it work for you. And when you own it free and clear, its tappable potential is at its greatest (see “Pros,” below).

Viable reasons abound for borrowing against your ownership stake, including:

• Improving or repairing your home
• Consolidating debt
• Paying college tuition or other educational expenses
• Buying a second home

While these are some of the most common reasons for tapping your equity, you can use the funds however you’d like. However, since your home will serve as the collateral for the debt, you should be judicious in how you tap it. Two good rules to follow: Use your equity in ways that improve your finances or work as an investment and don’t take out more than you can afford to lose.

Pros and cons of tapping equity on a paid-off house

Like any financial strategy, borrowing against your homeownership stake carries advantages and disadvantages.

The pros of tapping home equity

• Easier to get approved: It can be relatively easy to qualify for a home equity loan on a paid-off house since you already have a solid track record of paying off your first mortgage. Plus, once you’ve paid off your first mortgage, odds are your debt-to-income (DTI) ratio will drastically drop, which strengthens your financial profile.
• More money to tap: The less debt you have, the more you can borrow against your equity — so, if you still have a sizable chunk of your mortgage to repay, you’ll be limited in how much equity you can tap. But if you’ve already paid off your mortgage, you’ll have access to more money (virtually all of your home’s value, aside from the amount the lender requires you to keep untouched).
• No-strings money: You can use your equity for any reason. Most lenders won’t care, for instance, whether the money is put toward funding retirement, seeding a new business or making a down payment on an investment property.
• Tax advantages: When you use a home equity loan or HELOC to “buy, build or substantially improve” the home that secures the loan, you can deduct the interest from your taxes. This is known as the mortgage interest deduction. In addition, if you use the funds to fix up your home, it could reduce your capital gains liability — meaning that tapping your equity could be more beneficial than selling your home and downsizing.

The cons of tapping home equity

• Risk of losing your home: Of course, if you choose a form of financing wherein your home is used as collateral, like a cash-out refinance or home equity loan, there’s always the risk that you could lose your home if you can’t repay.
• Upfront expenses: While they often carry lower interest rates than unsecured loans, home equity products aren’t free. Most have upfront expenses and closing costs — like origination and appraisal fees — that you remember all-too-well from your first mortgage.
• Being frivolous with funds: You’ve worked long and hard to acquire this asset, so don’t blow it on one-time, discretionary expenses. Buying a car (a depreciating asset), paying for a wedding or taking a vacation are not-so-good reasons to deplete your equity stake.
• Diluting asset: When you borrow against your home, you’re essentially turning an asset into a liability, diluting your ownership stake and decreasing your overall net worth. Plus, instead of owning your home free and clear, you’ll add more debt (and a new monthly payment) to your plate.

Alternatives to using home equity

If tapping into your home’s equity isn’t the right fit, you might consider one of these financing options instead.

• Home improvement loans: These are typically unsecured personal loans explicitly designed for renovations and repairs. They usually come with fixed interest rates and set repayment terms. While rates may be higher than home equity loans, the upside is that home improvement loans don’t require using your home as collateral.
• Personal loans: Personal loans can be used for a variety of purposes, including home upgrades or debt consolidation. Most personal loans are unsecured, and approval will depend on your credit score and income. They offer plenty of flexibility, but like many unsecured loans, they may come with higher interest rates.
• 0% APR credit cards: Some credit cards offer promotional periods that charge no interest on purchases, generally lasting 12 to 21 months. This can be a good short-term financing option if you can pay off the balance before the introductory period ends. Keep in mind that after the promotional period, interest rates may increase significantly.

Bottom line

Determining whether it makes sense to pull equity out of a house you’ve already paid off really comes down to your circumstances, as well as your short- and long-term plans. As you did with your mortgage, it’s also important to consider whether you can commit to repaying a debt that can last for decades.

If you decide to proceed, make sure to practice the due diligence you would apply to any other financial transaction — shop around with several lenders and find the best terms for your needs.

Frequently asked questions

• What’s the cheapest way to get equity out of your home?

  A home equity line of credit, or HELOC, is typically the most inexpensive way to tap into your home’s equity. When opening a HELOC, you only pay interest on the money you actually use. As an added bonus, when using a HELOC, you won’t pay all the closing costs that come with a home equity loan or a cash-out refinance on a paid-off home.

• What credit score is needed for a home equity loan?

  Lenders typically look for credit scores of at least 620 on home equity loan applications. You’ll qualify for an even better rate with a score of 700 or above.

• What are alternatives to getting a loan on a house you own outright?

  There are a few alternatives to consider, depending on what you’re using the funds for and how much money you need. For example, if you’re buying a second home, you could always take out a new mortgage on that property. If you need cash for unexpected expenses, you could take out a personal loan or a credit card. However, the interest rates on these products tend to be higher than on home equity loans. Otherwise, you might be able to borrow from your retirement savings, but that comes with its own set of pros and cons.

Additional reporting by Larissa Runkle