When you have equity in your home, you could be sitting on the funds for your next loan, down payment, or renovation project. It’s one of the benefits of being a homeowner with a property that has accumulated equity.
However, there is a right and a wrong way to use it. Once you have an understanding of what equity is and the best and worst ways to use it, you’ll be able to decide how to move forward with your equity.
What Is Home Equity?
Home equity is simply the difference between your mortgage balance and the value of your home.
For example, if the value of your home is $300,000, yet the mortgage balance is only $150,000, you have $150,000 in equity.
Your home equity will fluctuate over time for various reasons. As your home value appreciates due to improvements you make, the area, or the economy, your equity will increase. Also, as you pay off more of your mortgage, your equity will increase. However, if your property value decreases, so will your equity.
How To Get Your Home Equity
If you have equity in your home, there is a process to get it out. One way is to borrow against it. The two most common methods are the home equity loan and the home equity line of credit, also known as a HELOC.
When you get a home equity loan, you receive a lump sum of money in a method similar to taking out a personal loan or a student loan. You make monthly payments on the total amount you borrow plus interest until it is paid back in full. It is a secured loan, and your home serves as collateral in case you default.
Your other option is a HELOC. This is similar to getting a credit card because you’re opening a line of credit instead of receiving one lump sum of money. So, you get approved up to a certain amount and can take out the money as you need it and pay it back over time. Similar to a home equity loan, you are repaying the amount you borrow plus interest. It is secured as well with your home serving as collateral.
Smart Ways For How To Use Home Equity
There are good and not so good ways to use your home equity. Here are a few recommended reasons to borrow against the equity in your home.
Finance a new home
Once you decide to sell your current home and you can use the equity to purchase a new one. This is an easy way to use your equity because when you sell your home, you automatically get any equity as your “profit” minus fees.
You can then take your equity and put it toward your new home. If you use it toward your down payment, you will borrow less, so you’ll pay less for your monthly payment. You can also use it to pay down debt before you apply for your mortgage, which will allow you to qualify for a more expensive property.
Using equity to fund home renovations that can increase the value of your property can be a great use of the money as well. When you make renovations, you want to balance the improvements you make with whether you’ll reap financial benefits from the changes. So, be selective with your repairs and renovations when using your home equity to fund them.
You can also use your home equity to consolidate your debt. This is best if you have over $10,000 in debt, and you’re struggling to pay high-interest rates and large monthly payments.
If you can significantly reduce your interest rates and combine your debts, so you’re paying less over the length of your loan, you’ll be able to experience significant benefits from using your equity to consolidate your debt.
Unfavorable Ways For How To Use Home Equity
While there are many great ways to use the equity in your home, there are some times when you want to avoid using your home equity.
If you’re unsure about your future with your company, you want to avoid taking out a home equity loan. This can be if you plan to leave your job or cut back on your hours, or if there are talks about your company going under.
The reason you want to avoid a home equity loan in these conditions is that your home is used as collateral in case you fail to make payments. Therefore, if there are any possibilities of you not being able to make payments, you don’t want to put your home at risk.
You always want to stay away from a home equity loan when paying for leisurely activities like vacations or a wedding. While these might be significant events in your life, you should seek another way to fund them or delay them until you can afford it.
While paying for college with your equity might seem like a great investment, there are generally more beneficial options to consider with more suitable terms and structures.
Understanding The Best Ways For How To Use Home Equity
If you have equity in your home, you might be tempted to put the money to use, and you should if it’s for a good reason.
Be sure to do your research on home equity and whether your purpose for taking out the equity will help you in the short term and long term.