There are numerous benefits to owning your own home. Not only does it provide a place to live, but it can also provide a source of funds. Over time, most homes increase in value, and many homeowners use their gains for a whole host of purposes. Using your home’s equity can be a low cost source of funds. With so many factors to consider it’s important to know your choices so you can make the most of your home.
Refinancing to get cash out
With a cash-out refinance, you refinance your existing mortgage and also borrow an additional sum from your equity at the same time, giving you cash that you can use for whatever you want. There is also potential to combine a cash-out refinance with getting a lower payment or interest rate. How much you can refinance for depends on the value of your house and the lender’s maximum allowed loan-to-value (LTV) ratio. The LTV ratio is the percentage of the home’s value that is financed. For example, if the lender has a maximum 85% LTV ratio, you can borrow up to 85% of the home’s value.
Home equity loans
With a home equity loan, you receive cash in one lump sum at closing. Once you get the money, you cannot borrow further from the loan. The repayment period is often fifteen years, although it can be as little as five or as great as thirty years. Both the interest rate and the monthly payments for a home equity loan are usually fixed, meaning they do not change over time.
Home equity lines of credit (HELOCs)
A HELOC is a type of revolving credit. It operates similarly to a credit card. You can withdraw money, up to your credit limit, at any time during the draw period. During the draw period, you typically are only required to pay the interest, although you can choose to pay principal as well. Once the draw period is over, you may have to repay the principal in full, be allowed to repay the principal over a fixed period of time, or have the option of renewing your draw period, depending on how the HELOC is set up.
The interest rate for HELOCs is usually variable, meaning it can change over time. It is usually calculated as a base index, such as the prime rate – the rate financial institutions give their most creditworthy members – plus a margin. Because the interest rate determines your monthly payments and how much borrowing will cost you, it is a good idea to find out how much the rate can change and if there is a cap that will prevent it from exceeding a certain amount.
What can the equity be used for?
By using your home’s equity, you are decreasing your wealth and increasing your debt, so make sure you are using the money for a worthwhile purpose. Do you really want to take out a home equity loan so you can go on cruise? Think about what you are planning to use the money for, and if it is worth depleting your home’s equity.
Popular uses of home equity include:
- Consolidating unsecured debt. Unsecured debts, such as credit cards and personal loans, often come with high interest rates. A loan secured by your home will usually have a better interest rate with smaller monthly payments. Also, if you have many accounts, consolidating them into one payment can make your life much easier. Still, it is important to keep in mind that you are turning unsecured debt into secured debt. If you do not pay your credit cards, your house cannot be taken from you, but it can if you do not pay your mortgage, home equity loan or line. Sometimes, when people pay off unsecured debt with their homes, they just wind up maxing out their old cards again, giving them more debt than before.
- Financing home improvements. Perhaps you want to change the cabinets in the kitchen, upgrade the bathroom, or add a whole new room. Home improvements can be expensive, and many people do not have the savings to pay for them. While renovations can increase your enjoyment of the house, as well as its value, people sometimes borrow so much that they cannot make the payments. Think about what you can afford to borrow and what projects can wait if you have limited funds.
What are the benefits?
In general, the lower the risk to the lender, the less interest you will have to pay. A loan secured by home equity does not have as much risk as a loan without collateral, so the interest rate for home loans is usually lower than that for credit cards and personal loans. The repayment period is usually longer as well, which makes borrowing large sums of money more affordable.
Chances are, you worked hard to buy your home. Making the right decision to use the equity in your home is important. We’re here to help explain your options and get to know your situation and help you make the best decision.