Your home equity isn’t just your ownership stake in the property: it’s also a valuable financial tool you can use during various circumstances.
If you want to learn how to use home equity to your advantage, read on. We’ll be taking a detailed look into a few ways to make the most out of your home equity.
Home equity is the portion of your property as measured by monetary value. For example, if you have 50% home equity in your property, you have a 50% ownership stake, which means your mortgage lender has the other 50% ownership stake.
Homebuyers can build up the amount of equity they own by making payments toward the principal of their mortgage loan, through their down payment, and by making home improvements that increase the value of the home.
Once you have built up equity in your home, you’ll have a few choices on how to access it. The most common is to opt for a home equity loan or a home equity line of credit (HELOC).
A home equity loan (sometimes called a second mortgage) involves using your equity as collateral to secure a lump sum of money paid to you upfront. The total loan amount will vary based on your total equity.
You’ll be given a set period where no payments are required. When that time expires, you’ll need to repay the principal balance of your home equity loan in monthly payments.
HELOC works slightly differently, as you’ll receive a credit limit based on your total equity and the loan-to-value (LTV) ratio. HELOCs have two distinct periods: a draw period and a repayment period.
The draw period is the time you can draw from your equity. Typically, the period will last several years, meaning your line of credit will be open and available the entire time. When the draw period ends, you’ll enter the repayment period, where you’ll pay down the balance.
It’s important to note that neither of these options will impact your current mortgage. You’ll still be required to make the monthly payments on your existing mortgage to your mortgage lender regardless of the conditions of your home equity loan/line of credit. Failing to make mortgage payments on time could result in foreclosure.
On the other hand, you can also access your home equity by opting for a cash-out refinance. Using this method, you’ll create a new mortgage to pay off the existing one and cash out your existing equity.
The mortgage rates will likely be much different than your current mortgage, but that doesn’t mean they’ll be better. You may end up with a higher monthly mortgage payment than you have now. It’s a good idea to take a long look at your financial situation before you opt for cash-out refinancing.
Keep in mind that lenders are bound to strict lending laws that require them to compare your monthly obligations to your income. This is called a debt to income ratio. Lenders are liable for ensuring they complete their diligence checks to offer a compliant loan.
Using your home equity can be risky — the last thing you want to do is sacrifice all your hard work by wasting your home equity on a home loan you can’t afford to repay. It’s essential to use your home equity wisely.
Here are five of the best ways to use home equity:
You can use a cash-out refinance or a home equity loan to consolidate high-interest debt. With a home equity line of credit or home equity loan, you can pay off credit card debt, personal loans, or other debts with very high fixed interest rates.
While creating a new loan, you can pay off the rest and enjoy a fixed-rate interest.
This can help you rebuild your credit score, but it's also a smart way to save money and reduce how much you pay on your monthly debts. Another bonus is you’ll be substantially reducing your debt-to-income ratio through this strategy.
Many homeowners dip into their equity from time to time to pay for various upgrades or home renovations. For instance, you can take out a home equity line of credit to get the money to purchase the supplies you need for home improvements.
This may be a great way to build up extra equity in the long run. For example, if you tap into your home equity to renovate your kitchen and add $2,000 of value to your property, you’re using equity to build up equity at the same time.
As you can imagine, this is a stellar strategy to maximize your future property value and monetary flexibility.
Using equity instead of a traditional loan to fund your home improvement project not only helps to improve the market value of your home, but it can save you money in the long run. Since home equity loans are secured by collateral, you’ll typically enjoy a much lower interest rate than a regular loan.
The lower rate could save you a significant amount of money depending on how much your project costs.
Another common way people use home equity is to cover unexpected bills such as medical expenses, replacing a broken down car, or any other twist that life takes.
Medical expenses are one of the most common ways that families go bankrupt. Tapping into your home equity can help you to pay down medical debts quickly and help to stabilize your finances during these turbulent times.
Depending on your financial goals, equity could be the lifesaver that you need to stay afloat and escape imminent hardship.
Private mortgage insurance (PMI) is an additional charge that reduces a mortgage lender’s risk of default. PMI is typically added to mortgages if the borrower can’t make a 20% down payment for their first mortgage.
Generally, you can remove mortgage insurance once your equity stake is 20% or more. In this way, you don’t have to take equity out of your property or sell it; continue to build equity until you hit 20%, then request the removal of PMI from your mortgage lender.
By doing so, you’ll save a little chunk of change every month, which can help you build equity even faster in the future.
While using home equity can seem attractive, many homeowners wonder whether it increases the risk of losing homeownership. That depends on who you work with and how you plan to access your equity. If you’re looking for a more secure equity investment, co-ownership with Balance might be worth considering.
If approved, we will pay off your mortgage balance entirely and replace it with monthly payments to us that cover your share of the monthly expenses and an exclusive occupancy fee. In return, we get an equity investment in your home and a percentage of the future equity appreciation.
Your name remains on the deed of your home, and you remain an owner in your home. You’ll be a co-owner with us, contrasting options like a reverse mortgage, where you enter into a lease after selling your property.
You’ll stay in your home, enjoy a shared home equity investment, and receive a lump sum of cash by selling us a portion of your equity.
Balance could allow you to use the equity you’ve built up in your property without risking losing ownership of your home. If approved for co-investment with Balance, you’ll stay in your home and always have the opportunity to refinance into a traditional mortgage and buy us out later.
Contact us today to learn more.
Sources:
Understanding your home's equity | Freddie Mac
What is private mortgage insurance? | Consumer Financial Protection Bureau
What Is Debt Consolidation and When Is It a Good Idea? | Investopedia
