By Rae Oakley, Flyhomes Mortgage
Talk to a financially savvy friend and they’ll tell you to make your assets work for you. If you own a home, you may have heard that savvy friend mention things like HELOCs and cash-out refinancing, but how much sense did those terms make?
I’m sure you’ve got some home projects you’d like to work on someday. Did you know home equity could help you pay for those as well as consolidate debt, restructure your investments, and even plan for retirement? Keep reading to find out how to unlock your home’s potential.
First, the basics: home equity is the difference between the value of your home and your outstanding principal owed on your mortgage. For example, let’s say you own a home valued at $700,000. If the principal balance owed on your mortgage is $500,000, then you have $200,000 of equity in your home.
There are two ways your equity can increase:
1 – You can pay down your principal balance
2 – Your home’s value can increase
On the flip side, your equity can decrease if your home’s value drops faster than the rate at which you’re paying down your mortgage balance. For example, let’s say after 5 years, your home value drops down to $650,000, but you’ve only paid off about $40,000 of your mortgage. That puts your equity at $190,000 ($650,000 – $460,000), a smaller amount than where you started.
If you’re curious about your home’s value, you can look at comparable home sales in your neighborhood or check various online real estate platforms. Remember, though, that these values are only estimates. The only way to find out your home’s value in the current market is to have a real estate appraiser conduct an official valuation to find out your home’s value in today’s market.
Now that you’re caught up, let’s talk about how to build your equity and how to use it. It’s easier to pay down your mortgage than increase your home’s value, so we’ll start there.
When purchasing your home, your down payment will be your first option for building your equity. Think of it this way: your down payment percentage is the amount of equity you’ll start off with. A 20% down payment might be the most common (though it’s not required), but if it’s within your means, you can certainly put down more.
You can also work towards reducing your mortgage balance to increase your equity. Paying more than the minimum on your monthly mortgage payments will help you systematically drive down your balance. Some mortgage lenders offer the option to set up bi-weekly payments, which means that you are paying 26 “half” payments throughout the year. Compare that to 12 “full” monthly payments (or 24 “half” payments) and you actually contribute an additional month’s worth of principal towards your mortgage each year, just by paying biweekly!
I mentioned earlier that your home’s value is difficult to control, but there are things that you can do to increase its relative value. Renovations and additions add value to your home, and outdoor maintenance like landscaping and gutter-cleaning increase your home’s curb appeal. A little TLC can go a long way in helping you build home equity!
Show me the money
Finally, you’ve come to a point where you want to start cashing in on your home equity. Well, how do you access it? There are three main ways to make your home work for you:
1 – A home equity loan
2 – A home equity line of credit (HELOC)
3 – A cash-out refinance
Home equity loan
A home equity loan is very similar to another mortgage. If you have $200,000 in equity, you can discuss your options with a mortgage professional to see how much of that value you can get approved to take out as a loan. Then, once the loan closes, you get the amount in a single lump sum payment, and you pay it off, with interest, in monthly increments.
If you have a specific project in mind with a certain budget, a home equity loan is a great option for you.
A home equity line of credit, aka a ‘HELOC’ (pronounced HEE – lok) is very similar to a home equity loan, except that instead of receiving the funds in a lump sum, you borrow against the credit line when you need it. Then, you pay back only what you use, similar to a credit card. For example, let’s say you qualify for a HELOC with a max spending limit of $50,000, but only use $10,000 for a renovation project, you only have to pay back the $10,000 (plus interest to your lender).
A HELOC is usually best for those looking to use their equity in various ways over a longer period of time, as the HELOC gives you flexibility in how much you’d like to use and when.
Cash out refinance
When you refinance and take cash out, you are applying for an entirely new mortgage that amounts to more than what you owe. For example, if your mortgage balance is at $300,000, but you have $100,000 in equity in the home, you might refinance to a balance of $375,000, which means you get to take out $75,000. This cash is provided to you at closing, and you can use it as you see fit. Now, your mortgage balance is $375,000, and you pay it back in monthly installments with interest, just as you did with your original mortgage.
This option works well for those looking to keep their debts relatively simple, because you’ll only have one monthly payment to make, rather than two if you were to take out a home equity loan or HELOC.
Once you have the cash in hand, there are a myriad of ways to use it. Only you can decide what’s best for you, but here are a couple options to consider.
Renovate and improve your home’s value
A small renovation can have a large impact on your home’s value and your quality of life. Consider investing in your home to help it appreciate in value.
Move on up
Tap into your equity when it comes time to look for a new home. If you’ve built a lot of equity in your current home, considering transferring as much of it as possible to your new home as a down payment to help you drive down your balance and decrease the size of your monthly mortgage payments. The smaller your mortgage, the more in property value you can afford. You might be able to afford a bigger, more expensive house with a smaller mortgage payment due to being equity-rich!
By paying down the balance on high-interest loans like credit cards, you can consolidate your debts and pay far less in interest. The average variable credit card interest rate at the time of writing is over 17%, whereas mortgage rates are near 4%. By paying off your high-interest debt and consolidating it on a home equity loan or cash-out refi, you could be saving hundreds in interest payments.
While pouring your savings in your home might be the best financial decision for you, there could come a time when you would want to consider using some of your equity towards other investments. Taking equity out of your home frees up cash for you to invest in other, potentially more lucrative opportunities.
With these options in mind, your mortgage consultant can help you find the option that’s right for you.
Thinking about taking some cash out?