There are a few different ways that you can tap into the equity in your home in order to get some extra cash. These include doing a cash-out refinance, getting a home equity loan, or opening a home equity line of credit (HELOC). Each of these can be used for things like home improvements, consolidation of debt, paying for college, or even emergency expenses. However, it is important to be cautious when borrowing against your home, as it is a big financial decision.
What is Home Equity?
Home equity is the portion of a home's value that is owned outright, free and clear of any liens or mortgages. Homeownership equity grows over time as a home's value appreciates and as the mortgage loan balance is paid down. Home equity can be used to finance large expenses such as home improvements, education or medical bills.
How home equity works
If you want to access the equity in your home, you will need to follow a process that is similar to getting a mortgage. You can apply through a bank, credit union, online lender, or another financial institution that offers these home equity products.
When considering a loan, lenders will look at several different factors to determine eligibility and what kind of rate to offer. This includes your debt-to-income ratio, loan-to-value ratio, credit score, and annual income. They will also hire an appraiser to determine the current market value of your home based on its condition and comparable properties in the area. This will help them determine how much equity you have in your home.
Why use home equity?
You can tap into your home equity to borrow large sums of money at favorable interest rates. This can be a convenient way to pay for home repairs or consolidate debt. It is important to determine what home equity product makes the most sense for your needs and to consult an expert if needed. How you plan to use your home equity should be considered when making this decision.
If you only want to borrow what you need and pay it back as you go, a HELOC may be a better option. With a HELOC, you only pay interest on what you spend, similar to how a credit card works.
A home equity loan may be the better option if you are looking for a fixed monthly payment and a large sum of cash up front.
5 Common Ways To Use Home Equity
There are numerous ways you can use your home equity, but some ways may be more beneficial than others. Whichever way you choose to use your home equity, make sure it aligns with your financial goals. Some of the best ways to use your home equity include:
1. Home Improvements
Home equity loans and HELOCs are a common way to finance home improvement projects. Not only can these upgrades make your home more comfortable, but they can also raise your home's value and interest from potential buyers when you sell.
Making improvements to your home is a great way to use home equity because these types of projects usually increase the value of your home. This makes home equity a great investment since it usually pays for itself by increasing the value of your home.
The ability to deduct the interest paid on home equity loans of up to $750,000 can be a great incentive to secure a loan for home improvements. This can be a great way to save money on your taxes while also making necessary improvements to your home. However, it is important to always consult a tax advisor before making any financial decisions of this nature.
2. Debt Consolidation
A home equity loan or line of credit can be a useful tool to consolidate high-interest debt at a lower interest rate. Some homeowners also use home equity to pay off other personal debts, such as car loans or credit cards.
This can be a very effective way to reduce your monthly expenses and consolidate debt under one lower interest rate.
3. Emergency Expenses
It is generally advisable to have an emergency fund equivalent to three to six months of living expenses, but this is not always possible for many Americans. If you find yourself in a difficult financial situation, such as being unemployed or having high medical bills, a home equity line of credit (HELOC) or home equity loan can be a helpful way to stay afloat. However, this should only be seen as a viable option if you have a backup plan or know that your current financial situation is only temporary.
Although you may feel better knowing that you could access your home equity in case of an emergency, it is still smart financial planning to set up and start contributing to an emergency fund. This will help you avoid serious debt down the road.
4. College Costs
If you're looking for a way to finance your child's college education, you may want to consider a home equity loan or HELOC. Many lenders allow this, and while student loans are still the most common form of payment, using home equity can be advantageous. This is because you may be able to get a lower interest rate on a home equity loan than you would on a student loan. Additionally, a home equity loan can extend the term of the debt, which would reduce your monthly payments.
If you're thinking about using a home equity loan to fund your child's education, be sure to calculate the monthly payments and see if you'll be able to pay off the debt before retirement. If it doesn't look like you'll be able to, it might be a better idea for your child to take out a student loan, since they'll have more years to pay it back.
5. Business Expenses
Some business owners use their home equity to finance business growth. If you have a business that needs more capital to grow, you might be able to get a lower interest rate by taking equity out of your home instead of taking out a business loan.
Before you decide to do this, be sure to calculate whether it makes financial sense for your business. Remember that, as with using your home equity to purchase investments, there is no guarantee that you will make money by doing this.
Important factors to consider
Before deciding to use equity from your home to finance a project or consolidate debt, there are a few things to consider. Even if you have a lot of equity in your home and think it’s a good option, there are potential risks and drawbacks you should be aware of.
Your home's value can decrease over time
No guarantees in life are certain except for taxes and death. Plan your finances and investments knowing that even home improvements may not secure an increase in value. If history is any indication, the housing market can be very unpredictable. This can result in your home losing a lot of value due to an economic downturn or major damage from a weather-related event.
It is important to remember that the value of your home is not guaranteed to increase over time. In fact, your home may lose value during an economic downturn, or suffer damage from fire or extreme weather. If this happens, you could end up owing more on your home equity loan or HELOC than your home is actually worth. This is sometimes referred to as being "underwater" on your mortgage.
For example, if you owe $500,000 on your mortgage but the home prices in your area have decreased and the market value of your home is now only $350,000, your mortgage balance would be $150,000 more than your homes' value. If your mortgage is underwater, it can be more difficult to be approved for debt refinancing or a new loan with more favorable conditions.
There's a limit to how much home equity you could borrow against
While the amount you can borrow from a HELOC or home equity loan varies from person to person, it is generally calculated using your loan-to-value ratio (LTV). Most lenders will not allow you to borrow more than 80 to 85 percent of the value of your home, minus any existing mortgage balances. Your credit score, financial history, and current income are all major factors that can affect your eligibility for a loan.
Understand how to NOT use your home equity
Most lenders and financial advisers would agree that using home equity to pay for unnecessary personal expenses is never a good idea. extravagant vacations or luxury vehicles might sound tempting, but it's better to save up for them using a regular savings plan rather than borrowing against your house.
In addition, when it comes to your home equity, always be mindful of how much you're borrowing. Even though you only pay interest with a HELOC on what you spend, like a credit card, its best to never overspend or put your house at risk of foreclosure for something that isn't truly worth it in the long run.
Even if you use your home equity to improve your home or financial position, keep in mind that failure to repay a home equity loan or HELOC could lead to foreclosure. Make sure you can afford the new payments and have a plan for improving your finances before taking out a home equity loan.
If you've decided that a HELOC is the right choice for you, getting a HELOC Card is a great option. Approval for a traditional HELOC can take several weeks, but a HELOC Card can take as little as 30 minutes. Plus, you won't need to go through home appraisal processes that traditional lenders use which can slow down the approval process. If approved, you should receive your card in a few days. After a three-day waiting period, you'll be able to use the card anywhere. With a traditional HELOC, funds are usually deposited into a bank account that you can access via online transfer or checkbook.
If you're interested in exploring a HELOC after doing your research, you can read more about what we're building at Chloe. You can also join our waitlist to get alerts when new educational resources are released, and to stay updated on when we'll be live in your market.