What Is Home Equity And How Can You Use It
You’ve probably heard that one of the benefits of buying a home is that you can build equity in it and tap into that equity to pay for a major kitchen remodel, eliminate your high-interest or even help cover your children’s college tuition.
But what exactly is equity, and how can you use it? Here’s a quick guide to the basics of how home equity works and why it’s so valuable.
How Do I Use Home Equity To Pay Off Debt
In order to tap your home’s equity to consolidate other debts, you’ll need to qualify for a home equity loan or line of credit. These loans will usually require a total combined loan-to-value ratio of no more than 85%, so your current loan balance will need to be less than that in order for you to have equity you can borrow. Your lender will also look at your credit score, debt-to-income ratio, payment history, and sources of income to determine if you qualify.
How To Use Home Equity
Equity is an important financial tool and one of the greatest financial benefits of owning a home.
You can tap into this equity when you sell your current home and move up to a larger, more expensive one. You can also use that equity to pay for major home improvements, help consolidate other debts or plan for your retirement.
Not all homeowners have equity in their homes. Fortunately, though, most do. And some owners are equity-rich, meaning they have at least 50% equity in their homes.
ATTOM Data Solutions, a property data provider based in Irvine, California, reports that more than 15.2 million homes in the United States were equity-rich as of the end of the second quarter of this year. Thats more than 27.5% of all the homes in the country.
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Theres A Limit To How Much You Can Borrow
Theres also a limit to the amount you can borrow on a HELOC or home equity loan. To determine how much money youre eligible for, lenders will calculate your loan-to-value ratio, or LTV. Even if you have $300,000 in equity, the majority of lenders will not let you borrow that much money.
Lenders generally allow homeowners to borrow up to 80 percent to 85 percent of the value of their homes, minus existing mortgage balances. That number can be different from person to person, though, and depends heavily on your credit score, financial history and current income.
Are Home Equity Loans A Good Idea
Whether a home equity loan is a good idea or not depends on your financial situation and what you plan to do with the money. Using your home as collateral carries substantial risk, so it’s worth the time to weigh the pros and cons of a home equity loan.
Fixed rates provide predictable payments, which makes budgeting easier.
You may get a lower interest rate than with a personal loan or credit card.
If your current mortgage rate is low, you dont have to give that up.
If you use the loan for home improvements or renovation, the interest may be deductible.
Less flexibility than a home equity line of credit.
Youll pay interest on the entire loan amount, even if youre using it incrementally, such as for an ongoing remodeling project.
As with any loan secured by your house, missed or late payments can put your home in jeopardy.
If you decide to sell your home before you’ve finished paying back the loan, the balance of your home equity loan will be due.
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You May Pay More Interest
This sounds counterintuitive. If you get a lower interest rate by securing your debt into your mortgage, how will you pay more interest? It depends on the length of time you borrow the money. Lets say you do a cash-out refinance and borrow the money for 30 years. Thats 30 years of interest payments. This could add up to be much higher than what you would have paid if you paid your credit card debts off sooner.
Of course, if you only make the minimum payments and have significant amount of debt, your credit cards could end up costing much more in the end.
Whether you should consolidate your debt into your home is a personal decision. Determine what you can afford and what habits youll have after you consolidate. If you think it will work out for the best, go for it. You likely stand to save a significant amount of money. If you are unsure though, evaluate your options and determine which option will work to your advantage.
Getting A Second Mortgage
A second mortgage is a second loan that you take on your home. You can borrow up to 80% of the appraised value of your home, minus the balance on your first mortgage.
The loan is secured against your home equity. While you pay off your second mortgage, you also need continue to pay off your first mortgage.
If you cant make your payments and your loan goes into default, you may lose your home. If thats the case, your home will be sold to pay off both your first and second mortgages. Your first mortgage lender would be paid first.
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Con #: It Doesnt Necessarily Solve Your Debt Problem
A lot of people have the misconception that a home equity loan is a magic bullet for getting rid of debt but its really more of a band-aid than a cure. When debt is created because of something unforeseeable, like a job loss or major illness, using your home equity to keep the collectors are bay may be the best solution. On the other hand, if youre thousands of dollars in because you have a shopping addiction or you just never learned to budget, borrowing against your home doesnt address the real issue and may just perpetuate the problem.
Tips Before You Get A Home Equity Line Of Credit
- Determine whether you need extra credit to achieve your goals or could you build and use savings instead
- If you decide you need credit, consider things like flexibility, fees, interest rates and terms and conditions
- Make a clear plan of how you’ll use the money you borrow
- Create a realistic budget for your projects
- Determine the credit limit you need
- Shop around and negotiate with different lenders
- Create a repayment schedule and stick to it
- What do they require for you to qualify
- Whats the best interest rate they can offer you
- How much notice will you be given before an interest rate increase
- What fees apply
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Using Equity For Your Retirement
If you’re 62 or older and considering retirement, you might explore a reverse mortgage1. With a reverse mortgage, you’ll stop making your monthly mortgage payments and will instead receive money based on the equity in your home.
How much you can borrow depends on your age and how much equity you have in your home as well as current interest rates.
You can elect to receive your proceeds in one lump sum, regular monthly payments or a line of credit. Any combination of the three payment types is also possible.
You don’t pay back your loan unless you sell your home, move out for more than 6 months out of the year or pass away. You would then use the profits from your home sale to pay back the loan.
If you pass away, your heirs have options. They can choose to sell the home , refinance into a regular forward mortgage or walk away and let the lender sell the home. A reverse mortgage is a nonrecourse loan, meaning your heirs wont be forced to pay back anything more than what they can get from the sale of the home.
Rocket Mortgage® doesnt offer reverse mortgages at this time.
How Home Equity Loans Work
When you take out a home equity loan, a lender gives you a lump sum of money that youll repay in fixed installments over time, usually five to 30 years. The amount you can borrow depends on the amount of home equity youve built.
Interest rates on home equity loans are usually lower than rates youd find on an unsecured personal loan or credit card because your home serves as collateral. But if you cant pay back the loan, your lender has the right to foreclose on your property.
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Things To Consider Before Using A Paid
When you borrow against a house that is paid off, youre introducing a financial risk that didnt exist before. Regardless of the loan product you choose, youll be exposing your home to the possibility of foreclosure if youre unable to afford the payments.
Before taking out a mortgage on a property you own, consider the following to determine if the benefits outweigh the risks:
Editorial Note: The content of this article is based on the authors opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.
Home Equity Line Of Credit Combined With A Mortgage
Most major financial institutions offer a home equity line of credit combined with a mortgage under their own brand name. Its also sometimes called a readvanceable mortgage.
It combines a revolving home equity line of credit and a fixed term mortgage.
You usually have no fixed repayment amounts for a home equity line of credit. Your lender will generally only require you to pay interest on the money you use.
The fixed term mortgage will have an amortization period. You have to make regular payments on the mortgage principal and interest based on a schedule.
The credit limit on a home equity line of credit combined with a mortgage can be a maximum of 65% of your homes purchase price or market value. The amount of credit available in the home equity line of credit will go up to that credit limit as you pay down the principal on your mortgage.
The following example is for illustration purposes only. Say youve purchased a home for $400,000 and made an $80,000 down payment. Your mortgage balance owing is $320,000. The credit limit of your home equity line of credit will be fixed at a maximum of 65% of the purchase price or $260,000.
This example assumes a 4% interest rate on your mortgage and a 25-year amortization period. Amounts are based on the end of each year.
Figure 1: Home equity line of credit combined with a mortgage
Buying a home with a home equity line of credit combined with a mortgage
- personal loans
- car loans
- business loans
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What Special Protections Are Available For High
A high-cost mortgage is a home equity loan that is: secured by your principal residence and the APR exceed certain threshold amounts that are tied to market conditions. If you have a high-cost mortgage, you may have additional rights under federal law, the Home Ownership and Equity Protection Act and the CFPB has more information about your special rights.
If instead you have a higher-priced mortgage with an APR higher than a benchmark rate called the average prime offer rate , you may have additional rights. You may be entitled to these rights if your higher-priced mortgage is used to buy a home, for a home equity loan, second mortgage, or a refinance secured by your principal residence. These additional protections do not apply to HELOCs. If you have a higher-priced mortgage, the CFPB has additional information about your rights.
Option #: Use Your Retirement Account To Pay Debt
Aside from your home equity, you may have another tangible asset you could use to pay off the debt in the form of your retirement account. If you have a 401 plan at work, for example, you may be able to borrow from it with a loan.
These loans often seem like a good idea because youre just borrowing some of your own money and paying it back over time. So, you can essentially borrow money with attractive terms, pay off your high-interest debtand then in a few yearshave your 401 replenished. But like using home equity to pay off debt, there are problems with this strategy.
Depending on your employer’s 401 plan terms, you could borrow as much as 50% of your savings, up to a maximum of $50,000, within a 12-month period.
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So Should You Pay Off Your Mortgage Early
If you find yourself with a little extra cash at the end of the month, should you put it toward your mortgage loan? Theres no simple yes or no answer. There are both risks and benefits to paying off your loan early, and the right decision will be different for everyone. In this section, well look at a few instances in which it makes sense to pay off your mortgage early and when it doesnt.
Do I Have Home Equity
If youve been paying off your mortgage for several years, then you likely have at least some home equity. As we explained above, you build equity as you pay down your mortgage. If you decide to use your home equity to take out a second mortgage, youll need to have your house appraised to determine how much it is worth. But, if youre simply curious about how much equity you have or want a general idea of how much equity you have before you head to your lender, heres how to do a quick estimate.
Home value= $376,000
80% of value = $300,800
How much you still owe on mortgage= $232,000
80% of your homes value amount you owe on mortgage= $68,800
In this case, you can expect to get a second for $68,800 or less.
Keep in mind that the number youll get from the above equation is just an estimate as youll only truly know the current value of your house when you get it appraised.
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You Can End Up Paying Less
The longer you carry a mortgage balance, the more interest you accrue. You still pay interest on a HELOC, of course, but you could score a significantly lower interest rate, especially if you took out a fixed-rate mortgage when market rates were high.
If that happens, then youll accrue lessinterest with the HELOC than you would with your original mortgage. Lessinterest accrued means a lower overall cost of the property.
Will I Owe Any Money On The Contract If I Cancel During The Three
If you cancel the contract, the security interest on your home is no longer valid, your home is no longer collateral and cant be used to pay the lender. You dont have to pay anything, and any amounts you paid must be refunded, including the finance charge and other charges, such as application fees, appraisal fees or title search fees, whether paid to the lender or to another company that is part of the credit transaction. The lender has 20 days after receiving your notice to return all money or property you paid as part of the transaction and to release their interest in your home as collateral, which they must do even though the security interest is no longer valid from the day the lender received your cancellation notice.
If you got money or property from the lender, you can keep it until the lender shows that your home is no longer being used as collateral and returns any money youve paid. Then, you must offer to return the lenders money or property. If the lender doesnt claim the money or property within 20 days, you can keep it.
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Con #: It Puts Your Home Equity On The Line
Unsecured debts, like credit cards, arent tied to any specific collateral. If you dont pay, theres the chance that you could end up getting sued but no one is going to come in and try to seize your personal property. A home equity loan, however, is backed by your property and if you find yourself unable to make the payments, theres the possibility that you could lose the home. If your income takes a hit and you dont have anything in savings to cover the gap, you could find yourself out on the street if the bank decides to foreclose.
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A home equity loan can be a useful tool for consolidating debt but its not always the right choice. Before you tap your homes equity, its worth it to look at every possible avenue to minimize the risks.