You want to renovate your kitchen, your kid is going off to college, or you need to consolidate some high-interest credit card bills. Big expenses come up from time-to-time and if you don't have thousands of dollars at your disposal, tapping into your home's equity could be an option for you.
Equity is the difference between how much your home is worth and how much you still owe on your mortgage. As you pay off your mortgage and as the value of your home increases, the more equity you have.
"Reports show 58% of homes have at least 60% equity. That is money you could have at your disposal to help improve your financial picture," said Kazantzis Real Estate Owner and Agent Andrea Kazantzis. "There are several different ways to tap into your home's equity. A qualified financial expert or mortgage broker can help you decide which option is best for you."
There are three main ways to access the equity in your home. Which one you choose depends on what you want to do with the money.
A second mortgage - also known as a home equity loan - is a structured, secured loan with a set term, similar to a regular mortgage. All of the money is disbursed upfront. While interest rates are typically higher than your primary mortgage, rates will likely be lower than an unsecured personal loan. There are closing costs associated with this loan.
Because this is a lump-sum loan, they're often used for debt consolidation, educational expenses, medical expenses, or any other expense that requires a lump sum.
Home Equity Line of Credit (HELOC)
A home equity line of credit is the most flexible of your options. You get approved for a certain amount and, during the draw period, you can borrow money against the line of credit as you need it - similar to a credit card. This may be a good option if you're making a series of home improvements or launching a small business.
During the draw period - which is typically 10 years - you can take out the money as you need it and will likely only have to make payments on the interest of what you've borrowed. Then during the repayment period, you'll need to make payments on both the principal and interest, but only on the amount you've borrowed.
With a traditional refinance, you take out a new loan for what you already owe, typically with better terms. However, with a cash-out refinance, you borrow more than what you owe on your home and get the difference in cash. You can typically borrow up to 85% or 90% of your home's value and can use the money as you see fit. There are closing costs with this option as well.
This may make sense for you if your home's value has increased and you can get lower rates. By using cash to pay off a car loan or credit cards, you may increase your monthly cash flow.
Ways to Use Your Equity
Now that you know about the different ways to access your equity, how should you use it?
One of the most common uses of a home's equity is to make home improvements. Many times these renovations will pay for themselves by increasing the home's value. Projects that often yield a solid return are kitchen and bath renovations, garage and entry door replacements, a new deck, new roof, or the addition of a patio.
There's no way around it - college is expensive. Because interest rates are lower than student loans, a home equity loan or HELOC may be a less expensive way to finance your child's education. In addition, the term of the debt can be extended, reducing the monthly payments.
Paying Off Debt
Whether it be high-interest credit cards or a big medical bill, using the equity in your home to consolidate your bills at a lower interest rate may help lower your payments, saving you money each month.
Things to Consider
Before using the equity in your home, you should consider a few things to determine if it's right for you.
1) If your home declines in value, you could end up "underwater" or owing more than your home is worth.
2) There is a limit to how much you can borrow. Lenders will typically let you borrow up to 80% of your home's equity.
3) Avoid using your home's equity for frivolous personal expenses - like vacations or a fancy car. You're better off saving money to pay for these fun, but unnecessary expenses, rather than putting your house at risk of foreclosure.