Property rates have been rising everywhere over the last few years, and that has a lot of folks looking closely at their home values. Many may realize just how much equity they have built. It’s not cash sitting in a bank account, but it is real wealth and an asset you can, with a little effort, leverage as needed. In fact, once you know it’s there, you may have a difficult time not thinking about how it could be used.
To be sure, your home equity can be a useful financial tool – but it’s not free money, and it’s not without risk. The key is knowing when it makes sense to access your home equity and when you’re wiser leaving it alone.
What Is Your Home Equity, Exactly?
Your home equity is the difference between what your home is worth and what you still owe on your mortgage.
For example, if your home is valued at $350,000 and your remaining loan balance is $200,000, you have $150,000 in equity. That number can grow over time as you pay down your loan and your property increases in value. Because of dramatic shifts in real estate values in a lot of areas, many homeowners are happily discovering that they have much more equity than they ever thought possible at this stage of their lives.
You can generally access that equity through options like home equity loans, home equity lines of credit (HELOCs) or cash-out refinancing. Each allows you to borrow against the value you’ve gained in your home, but they work slightly differently.
The Dos of Using Home Equity Wisely
If you approach the situation carefully, home equity is a tool that can make it easier to follow your dreams and achieve your goals. Below are some guidelines to follow when accessing equity.
Do use equity for home improvements that add value
Some home projects pay you back, while others don’t. Upgrades to kitchens, bathrooms, roofing, plumbing, electrical and HVAC systems tend to hold their value better than purely cosmetic changes. Using equity to improve your home can increase both your comfort now and your home’s resale value later, which makes it one of the more practical approaches.
Do consolidate high-interest debt carefully
If you’re dealing with high-interest credit card balances, using home equity to consolidate that debt into a lower interest rate can make sense. That can be beneficial if it reduces your monthly bills and makes your finances manageable. All that being said, it’s still important to address the underlying issues that created the debt in the first place. Otherwise, it’s easy to fall back into unhealthy spending habits and end up with both a loan and more credit-card debt.
Do use the money for major, necessary expenses
There are times when large expenses are unavoidable. Medical bills, essential home repairs or education costs may justify tapping into equity, especially if the alternative is high-interest borrowing. Launching your own business is another good reason to borrow against your home. In those cases, your home equity can fund an investment in your future and keep your life stable.
Do keep a cushion
Just because a lender is willing to let you borrow a certain amount doesn’t mean you should drain every dollar. Leaving some of your home equity untouched gives you flexibility if your financial situation changes.
Do understand the terms of the loan
Before moving forward, make sure you understand how your loan works. Look at interest rates, repayment schedules, fees and whether the payment and interest rates are fixed or variable. A HELOC with a low introductory rate can look appealing, for example, but payments can increase later when the rates rise. If you aren’t prepared, you could find yourself financially strained with balloon payments due.
The Don’ts That Can Lead to Trouble
It is always wisest to approach the idea of tapping into your home equity with a modicum of caution. There are real consequences for mistakes. Some good rules to remember include some of those mentioned below.
Don’t treat equity like extra spending money
If you’re sitting on a small fortune, it can be very tempting to “live a little” and use the equity
for a family vacation, luxury purchases or lifestyle upgrades. The problem is that your equity isn’t “extra” money; It’s debt secured by your home. What feels manageable now can become a long-term obligation that wears you down.
Don’t forget what’s at risk
When you borrow against your home, you’re putting your home at risk. If you fall behind on the payments, foreclosure is a possibility. That’s a much higher risk than you’re likely to have with a credit card or unsecured personal loan.
Don’t assume your home’s value will always rise
Markets change. Borrowing heavily against your home based on current real property values can leave you in a tight spot if there’s a “market correction” and home prices suddenly decline. A margin of safety matters. Always take only as much as you truly need.
Don’t use equity to cover ongoing expenses
If you find yourself relying on your home equity to cover your regular bills or fill an income gap, that’s a sign of a deeper financial issue. Equity is not a long-term solution for financial woes, and using it that way can leave you in a much worse position.
Don’t skip professional guidance when needed
There are situations where it’s worth talking things through with a financial advisor or mortgage professional. A second opinion can help you spot risks or alternatives that aren’t immediately obvious.
Choosing the Right Way to Access Your Home Equity
If you decide to move forward, you need to consider the options carefully:
- A home equity loan provides you with a set amount of money, all distributed at once. The interest rate and monthly payments are usually fixed and stable. This option works well for one-time expenses where you know exactly how much you need.
- A HELOC works more like a line of credit. You can borrow as little as you want or as much as you need, up to the limit you’re given, during a specific “draw” period. Interest rates are usually variable, however, which means you won’t have a set payment. A HELOC offers flexibility, but it also requires discipline to avoid overborrowing. It can be perfect for things like home repairs, however.
- A cash-out refinance replaces your current mortgage with a new, larger one. You receive the difference between what you borrow and your home’s value in cash, but you’re also resetting the terms of your loan. That usually increases what you pay each month and how long you’ll pay it. This is often the best option for people starting a business, funding an education or something similar.
The right choice depends on your goals, your timeline and how comfortable you are with the financial risk. A loan professional can help you decide.
Home equity is a resource, but it’s also a responsibility. It represents the portion of your home that you truly own. Once you borrow against it, you’re trading an asset for a debt. That doesn’t mean you should never use it – but it does mean you should have a clear reason and a plan for how it fits into your overall financial picture.
bill.ingram@talktotucker.combrad.layton@talktotucker.comeditors-pickerina.pribyshchuk@talktotucker.comfeaturedlloyd.zimmerman@talktotucker.commark.callahan@talktotucker.commary.layton@talktotucker.compriscila.hale@talktotucker.comterri.mcgraw@talktotucker.com
