Mortgage Q&A: “Can I mortgage a house that I pay off?”
When you own a home without any mortgages attached to it, it is known as “free and clear” property.
Some see this as a good thing, while others see a mortgage as a good debt that doesn’t need to be paid off ahead of schedule (or at all).
Others argue that you should not take out a mortgage in retirement, because you will have a fixed income and that could be a major expense.
If you have a home that’s fully paid off, you may wonder if you can get another mortgage. Let’s talk about that.
Yes, you can get a mortgage on a home free and clear.
Without getting into the technicalities here, the short answer is Yes.
If your property is free and clear of any debts or liens, you can get a mortgage, assuming you otherwise qualify.
This means having the income, assets, employment and credit history to qualify for the loan.
In fact, it shouldn’t be much different than what you got when you got the original loan. Although it will be considered a cash-out refinance rather than a home equity loan.
If you own your home outright and there are no existing loans tied to the property, taking out a new loan means tapping into equity.
When you tap into equity, it’s known as a cash-out refinance because you’re taking what you already have and putting it into your bank account.
The loan process is mostly the same as the purchase process minus a few details, such as the purchase contract and down payment.
Instead of taking out a home equity loan, any amount borrowed will go into your pocket, minus closing costs.
You will then get a new loan term, mortgage rate, monthly payment, etc.
The loan will be considered a cash-out refinancing
As mentioned earlier, a home mortgage with no outstanding liens will be treated as a cash-out refinance.
Typically, cash-out refinances are priced higher than other types of loans, and there are more restrictions in terms of how much you can borrow (the maximum loan-to-value (LTV) ratio is lower).
Of course, if the house is paid for in full, you’ll likely have a pretty big cushion to get what you need without getting that far.
Anyway, the word refinancing basically means financing again, and that’s exactly what you’re doing when you take out a paid-off home loan.
But it is different from the refinancing rate and term, which pays off the existing home loan and creates a new loan.
Let’s look at an example:
Let’s say you have a $500,000 house that was paid off in full two years ago.
Now imagine that you need money to cover some other expenses, such as university fees or even buying a different house, or perhaps for a vacation or investment property.
If mortgage rates aren’t bad, you might consider borrowing against your paid-off home.
Often times, a mortgage can be the cheapest option compared to other types of loans, be it a credit card, personal loan, etc.
The longer loan terms associated with the mortgage also keep monthly payments lower, assuming that’s the feature you’re looking for.
Let’s say you want/need $200,000. You could simply refinance your home, withdraw that money, and you would now have a $200,000 mortgage on a $500,000 home.
You get the cash you need but you have to pay back a $200,000 loan with a corresponding monthly payment, perhaps for the next 30 years.
As a result of the new lien, your home is no longer paid for. It may take some time for this to happen again.
You now have to make a monthly mortgage payment, which can be expensive, especially if you’re used to living without it.
Most mortgages feature 30-year loan terms, so they can stay with you for a while (although there are shorter terms available such as 15-year fixed and even 10-year fixed).
Can I get a home equity loan on a home that is fully paid off?
I have now presented a possible scenario above. But a cash-out refinance isn’t the only way to get home equity out of a paid-off home.
There are many alternatives to a cash-out refinance, including a home equity loan or a home equity line of credit (HELOC).
While home equity products are typically second mortgages taken out while the homeowner still has their first mortgage, they can be standalone products as well.
So it’s entirely possible to get a HELOC on a home you own outright, borrow only what you need, and then pay it back quickly. Then use the credit line again if necessary.
Or take out a smaller lump sum through a home equity loan and pay it off over a shorter loan term to reduce interest expenses.
The trade-off with the shorter term is that the monthly payment is higher, but much less interest is paid. That could be a win, but it could also make qualifying more difficult.
Ultimately, you’ll need to select the loan product that offers the best rates and aligns with your return goals.
I’ve already written extensively about cash for home equity loans versus HELOCs. So, if you want a handy guide to comparing software, be sure to check it out.
Other than that, there are also reverse mortgages for seniors, which have no monthly payment but reduce your sales proceeds if you sell.
and home-sharing arrangements, which carry no monthly payment at all. But you’re giving up future home price appreciation, which could be much more expensive (I’m not a fan).
In short, a paid-off home means you have many options to choose from if you need to borrow money, whether that’s a refinance or a home equity line/loan.
Just know what you’re getting into and realize that you can restart the clock if your goal is to own a home without a mortgage!
(picture: pompous)
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