You'll gradually build up equity when you purchase a property and begin making regular mortgage payments. But the equity in your home doesn’t have to just sit there; you can make it work for you in various ways.
When taking some of the equity out of your home, you must know what to expect and how to do it wisely.
Let’s take a closer look at home equity.
Home equity is the percentage of your real estate that you own — think about it as your stake in your house compared to your mortgage lender’s stake.
Your home's equity is the difference between how much your home is worth and how much you owe on your mortgage plus any other liens.
You can increase your equity by making a large down payment, paying down the principal balance each month, or if your home's value increases.
Building equity is about more than home prices and the property value of the home. It’s also about how far into the loan term a homeowner is and how much of the original mortgage they’ve paid off — in other words, how much of their home they truly own outright.
You can also build up equity in your property by making home improvements that add to its market value (adding a backyard deck, renovating the kitchen, and repairing the roof).
There are a few effective ways to take equity out of your home, after which you can use that money for various purposes.
Some popular ways to take equity out of the home include:
Home equity loans are fixed-rate second mortgages repaid over a certain amount of time, usually 15 years. These amortized loans require dividing your payments between the interest and principal amounts. The total home loan amount that you can receive will depend on your equity and current mortgage balance.
HELOCs function like traditional lines of credit, but you borrow against the equity in your property, which serves as collateral. The credit limit is based on the total equity you have in the property and the loan-to-value (LTV). You can continually draw from your HELOC up to the borrowing amount during the draw period, then repay whatever you owe during the repayment period.
This is similar to using a credit card in that you have monthly payments, and your limit is based on your credit score. A HELOC usually has a lower interest rate than a personal loan or even the best credit card; however, it is important to note that the monthly payments are interest only and the loans are adjustable so they are subject to change with market conditions.
Additionally, when you pay interest on HELOCs, the payments can be tax-deductible.
With a cash-out refinance, you refinance your home for a larger loan amount, and you can pocket the difference in an upfront cash payment. Your equity serves as the source of the cash.
Note that this method requires you to pay your mortgage loan over a longer period of time than your current mortgage.
Any type of loan or line of credit listed here is partly based on the value of your home.
Fortunately, you can use many of these tools for things like home renovations, debt consolidation, paying credit card debt, or improving your debt-to-income ratio (a key indicator of your general financial situation).
However, ensure you have enough equity in your home to fund your financial goals adequately.
No matter which method you use to take equity out of your house, you should expect a few significant things to happen.
Taking equity out of your home usually results in a fast lump-sum payment. Taking equity out of your property could be ideal if you need cash quickly for a financial emergency, like medical bills or job loss.
For example, if you use a cash-out refinance, you'll receive a lump sum payment for the equity in your property, which you can use as you please. You don’t usually need to worry about a higher interest rate if you use a loan option that results in a lump-sum payment.
You may end up with a lower rate if you’ve improved your credit score since the first mortgage.
Keep in mind that taking equity out of your home and exchanging it for cash reduces your ownership stake in the property.
For instance, if you have 40% equity in your house and take out 20% of that equity in a lump sum payment, you’ll only have 20% equity or ownership stake in the property remaining.
You can rebuild that equity over time, but this is still something to consider if you’re thinking about selling your house soon.
For many homeowners, taking equity out of the home increases financial flexibility. That's because the money you receive from selling your equity doesn't come with many strings attached.
Depending on the financial instrument you use, the equity cash may not have any interest rates or fees at all. Not only that, but most home equity lines of credit and similar types of loans don’t impose usage limits or requirements for cash.
With Balance, you can enjoy the flexibility to consolidate your debt, repair your home, catch up, and build your credit.
Homeowners must ask themselves whether taking equity out of their property is wise.
In many cases, taking equity out of the home could be an excellent decision. If, for example, you have an unexpected debt or medical bill and don’t have any other way to produce a lump sum of cash, drawing from your house’s equity can help you avoid financial stress or taking on dangerous high interest debt.
Sometimes it is good to take an advanced draw on your equity because if you sell your home before your credit has improved you may block yourself from future options. Some borrowers access equity before selling to build their credit so they can qualify for their next chapter.
Of course, there are a few ways to avoid these downsides. For example, if you partner with Balance, our equity investment will give you a lump sum of cash and allow you to stay on title and in your property as a co-owner.
You would maintain the option to repurchase the equity from us by refinancing it into a traditional mortgage whenever you want, or selling the home. It’s worth considering, as you should review your financial options carefully before tapping into your home equity.
Ultimately, taking equity out of your home could be an excellent idea, especially if you need a lot of cash fast. However, it’s important to remember that equity isn’t free money: there are always strings attached.
When you partner with an equity investor like Balance, you’ll have the financial flexibility that you need to get your finances back on track until a later time when you buy us out of our share of the equity.
Contact us today to learn how we can help you to make the most of your property’s equity.
Sources:
Equity Definition: What it is, How It Works and How to Calculate It | Investopedia
What Is a Cash-Out Refinance? | Experian
What is a home equity loan? | Consumer Financial Protection Bureau
