Many homeowners looking for cash turn to the equity in their homes. Tapping your home's equity can allow you to consolidate debt, pay medical bills or college tuition, make home improvements, or other investments. Understanding the different methods for converting equity to cash will help you match your loan to your purpose. 

Cash-Out Refinance

A cash-out refinance involves taking a new first mortgage, paying off your old one and adding the extra cash you need to the loan amount. This method works well when

• You have a cushion of equity to draw on (a cash-out refinance could cost you private mortgage insurance if your new loan amount exceeds 80% of the value of your home).
• You have a current loan with terms that could be improved by refinancing.
• You plan to remain in your home long enough to break even on the costs of refinancing.

Refinancing a first mortgage and taking cash out involves higher fees than obtaining a second mortgage or HELOC. However, if you're refinancing to more favorable terms, a cash-out refinance could offer the greatest savings of all your options.

Second Mortgages

In general, you'll pay a higher interest rate on a second mortgage than with a cash-out refinance loan. That's because a second mortgage is positioned behind your current mortgage. This means the holder of the first mortgage gets paid first in the event of a default, and therefore a second is riskier to the lender and commands a higher rate. Second mortgages are much less expensive to obtain than first mortgages, and the rates are generally lower than those of consumer debt like car loans or credit cards.

Fixed Second Mortgage

A fixed rate second mortgage delivers a lump sum at closing, the rate is fixed, and you make equal payments for the entire term of the loan, which can range from 5 to 20 years. This loan is best when you need cash in one shot, to pay off debt, medical emergencies, or for financing investment property 

Home Equity Line of Credit (HELOC)

A HELOC allows you to use funds only as you need them, and pay interest only on the outstanding balance. If you need money over time, such as for tuition, a long home improvement project, or just want a safety net in case of a financial problem later, choose a HELOC for this flexibility.

Tax Benefits

Both interest on cash-out refinance loans and HELOCs are usually tax deductible but there are strict IRS guidelines. If your loans exceed the value of your home or you have second mortgages totaling $100,000 or more (even if on several properties) you may be unable to deduct the interest. And if you don't itemize your deductions the deductibility of interest doesn’t matter to you. Be sure to check with your tax advisor 

Make Sense?

It may not make sense to do a cash-out refinance or take a second mortgage if you want cash for something such as a vacation, clothing, or car. But if you're looking for money for a long-term goal or improvement such as starting a business, paying education costs, or fixing up your home, it may be a better deal.  As with any financial move you make, do your homework and understand all your options before signing any contracts. Check with a finance pro about the tax and investment consequences of any large financial decision. Too many people consider their home a piggybank without understanding all the pros and cons and using that equity intelligently.