If you own your home, then you may have equity in the property. If you do, then should you tap this locked up equity and use it? There is no black and white answer. Some uses of your home’s equity are foolish while others can help you build wealth. I’m going to look into a few uses of your home’s equity. See if any of these make sense for you.
How Does This Work?
So, what exactly am I talking about here, and how do you go about using the equity in your house? Your house is an appreciating asset, in most cases. As you live in it, make improvements, and pay down your mortgage, your house will be worth more over time. Real Estate generally appreciates long-term. After several years you may find that your home has a substantial amount of equity locked away. You’ll need to talk to a lender in order to get a hold of it.
HELOC
Enter the HELOC, or home equity line of credit. It is one of the most common ways to tap your home’s equity. Applying for a HELOC is like applying for a mortgage in that the lender will need to perform an appraisal on your home to determine its market value. The process is, however, much simpler and straightforward. There are often no or low closing costs as well.
Once established, you will have a predetermined line of credit that you can use such as a credit card. You then pay back the loan in monthly installments over a predetermined term. A HELOC offers the advantage of flexibility to use the credit line as you wish. Interest rates are often low and the payments are typically lower than other forms of financing due to the longer term.
A few words of caution. Running up your HELOC account will result in a reduction of the equity in your home should you need to sell in the next few years. Interest rates are typically variable, so a jump in interest rates could result in a larger payment. HELOC abuse was one of the main reasons for the housing crisis in 2008, so use caution. A HELOC should not be used for consumer spending such as funding a vacation. Finally, failing to make the payments could result in foreclosure, as the collateral on the loan is your home.
Cash-out Refinance
Another way to tap into your home’s equity is to do cash-out refinancing. A cash-out refinance replaces your existing mortgage with a new mortgage for more than the balance of your existing loan. The difference will be paid out to you as cash at closing. The cash that you receive is the difference between your mortgage balance and the value of your home. The cash out will be limited to somewhere between 70% and 90% of your home’s value. You can’t take out 100% of your home’s value.
If you have a home worth $200,000 and have a $100,000 mortgage, then you have $100,000 in equity in your home. You could do a new mortgage for $150,000 and receive a check for $50,000 at closing. This $50,000 can now be used for anything that you want.
Beware that by doing this you will be raising your monthly payment. The interest rate may also be higher depending on when you originally purchased your home. Also, much like a HELOC, you shouldn’t use the money for consumer spending or for home improvements if you are planning to move soon or are trying to increase the value of your home before selling. You almost never recover renovation costs in a sale. Also, as with a HELOC, your home is considered collateral should you default on the payments – making you subject to possible foreclosure. You may be subject to PMI if you take out more than 80% of your home’s equity, so keep this in mind. Lastly, do your homework on the fees and interest rates on a refinance to see if it makes sense in your situation.
Some Final Thoughts
Pulling the equity out of your home via a HELOC or a cash-out refinance is a means to use the equity that is locked away in your primary residence. The money can be used for anything, but you should do your homework before proceeding, and you need to be aware of the risks.
Paying off high-interest debt such as credit cards can be a good financial strategy so long as you have changed your behavior that caused the debt in the first place. In other words, don’t use this as an excuse to run your credit card debt up again.
Home improvements can be funded via your home’s equity, but only do so for personal reasons and with a long-term time horizon. Don’t do this if you are trying to sell your home thinking that remodeling will command a higher selling price. You may get more, but the cost of the remodel will more than likely outweigh your increase in selling price.
Some investors will use the equity in their primary residence to buy investment properties or fund a business. This can be a powerful tool in that arena, but it is beyond the scope of this article. Just know that it is a possibility.
Be aware of the risks associated with using your home’s equity and do your homework to make sure it makes sense for your situation. Once you are confident that this could be a good financial move, then you will have a very powerful tool at your disposal.
See Also:
8 Types of Mortgages to Take Note Of: Which One Is the Best for Your Needs?
5 Little Known Financial Secrets About Mortgage Loans
Want to Refinance Your Mortgage? Lessons Learned from an Average Joe
Traditional vs Interest-Only Mortgage
Based in the Pittsburgh, PA area, Brian holds full-time employment as a Warehouse Manager for an electronics firm. Brian enjoys wealth building, investing, gardening and the great outdoors. Brian holds a B.A. in Environmental Studies from the University of Pittsburgh and an MBA from Robert Morris University.
