Living Trusts

Home Equity: What It Is and How To Use It to Your Advantage

If you’re a homeowner, you have one of the most powerful tools at your disposal: home equity. This is the portion of your home’s value that you actually own — and it can be used to your advantage in a number of ways. This post will review what home equity is, how to calculate it, how to access your home equity, and the best and worst uses for using your home equity.

What Is Home Equity?

Home equity is the portion of a home’s value that the homeowner owns. Chances are, when you purchase a home, you’ll need to take out a mortgage in order to finance the purchase. Your down payment is your initial equity in the home, and each month, a portion of your mortgage payment goes toward paying off the principal loan amount. As you pay down the principal, your equity in the home increases. In addition, if your home’s value goes up over time, your equity will increase as well. You can build equity in a number of ways, but making regular mortgage payments is one of the most effective. As you’re making those monthly payments, remember that you’re not only paying for a roof over your head — you’re also building equity in your home.

How to Calculate Your Home Equity

To calculate your home equity, you’ll need to know two things: the current market value of your home and the amount of money you still owe on your mortgage.

For example, if your home is worth $500,000 and you still owe $300,000 on the mortgage, your home equity would be $200,000 ($500,000 – $300,000).

It can be difficult to put an accurate value on your property. Online sites such as Zillow and Redfin can give you a rough estimate of your home’s worth, but for the most accurate assessment, you’ll need to consult a professional. A certified appraiser will inspect your home and consider factors including location, square footage, and recent sales in the area to determine its fair market value. Or, if you’re working with a real estate agent, they can provide you with a Comparative Market Analysis (CMA), which compares your home to similar properties that have recently sold in the area.

How to Access Equity in Your Home

Now that you understand what home equity is, let’s take a look at some ways you can access it for your benefit.

Home Equity Loans

A home equity loan is a loan that uses the equity in your home as collateral. These are also referred to as second mortgages. These loans will give you a lump sum and then be paid back in equal payments over time, in addition to your mortgage. Because home equity loans are secured by your home, they usually have lower interest rates than unsecured loans, such as credit cards or personal loans. However, if you default on a home equity loan, you could lose your home to foreclosure. Before taking out a home equity loan, it’s important to understand how they work and the risks involved.

Home Equity Line of Credit

A home equity line of credit, also known as a HELOC, is a great tool for homeowners who need access to extra funds. It works similarly to a credit card in that you can borrow money up to a set limit, and you only pay interest on the amount that you borrowed. This makes it a flexible and convenient option for financing home repairs or other unexpected expenses. However, it’s important to note that most HELOCs require an initial draw, which means that you’ll need to borrow at least a certain amount of money right away. The interest rate on a HELOC can also vary daily, so it’s important to compare rates before you apply. But overall, a home equity line of credit is a great way to get financial flexibility.

Cash-Out Refinance

A cash-out refinance is a mortgage refinancing option in which the new loan is for a larger amount than the existing loan in order to convert home equity into cash. The difference between the two loans is then given to the borrower in cash. This option can be beneficial for borrowers who have built up significant home equity or who need to make repairs or improvements to their home. However, it is important to remember that a cash-out refinance will typically have a higher interest rate than a traditional mortgage and increase your monthly payment since you are borrowing more money than the original mortgage. Therefore, it is important to carefully consider whether this option is right for you before proceeding.

How Much Equity Can Be Accessed?

When you borrow against your home, the financial institution is using your property as collateral. They won’t lend you the full value of your home equity because they don’t want to take on the risk that if house prices drop, they would be carrying a loan for more than its market value. For this reason, most banks will allow qualified homeowners to borrow up to 80% of their home equity, but this can vary depending on the type of property, your credit history, and other factors. 

Smart Ways to Leverage Your Home Equity

If you’ve built up equity in your home, congratulations! That’s a great accomplishment and you may be able to leverage it for other expenses. Here are a few smart ways to leverage your home equity:

  1. High-Value Home Improvement Projects

If you have equity in your home, you may be able to use it to finance home improvements that can increase the value of your property. While all home improvement projects have the potential to add value to your home, some are more likely to offer a higher return on investment than others. For example, kitchen and bathroom remodels are often considered to be wise investments, as they can attract a wide range of buyers and lead to a significant increase in resale value. Other high-value projects include adding an extra bedroom or bathroom, finishing a basement, or replacing an old roof. By carefully selecting home improvement projects that offer the best return on investment, you can use your equity to add value to your property and improve your financial position in the long run.

  1. High-Interest Debt Consolidation

Home equity can be a powerful tool when it comes to managing your finances. By taking advantage of the equity you’ve built up in your home, you can access low-interest loans that can save you money on interest payments and help you pay off debt faster. One of the smartest ways to use home equity is to consolidate high-interest debt. By taking out a new loan with a lower interest rate and using the proceeds to pay off debt with higher interest rates, you can save yourself a significant amount of money in interest payments. Consolidating your debt can also help you simplify your finances by giving you one monthly payment to manage, instead of multiple payments with different due dates.

  1. Investing in Real Estate

Leveraging your home equity can also be a great way to finance an investment property. This can provide you with a steady stream of income and help you build wealth over time. When you use home equity to finance an investment property, you’re essentially using your property as a down payment, which can make it easier to qualify for a loan. By using home equity to invest in real estate, you can take advantage of the incredible returns that this market often offers.

  1. Costs of College

One of the major expenses that many families face is the cost of college. As tuition rates continue to rise, more and more families are finding themselves struggling to come up with the necessary funds. However, there is one way to ease the financial burden associated with college: by taking out a home equity loan. Home equity loans can be used for any purpose, including paying for tuition, room and board, and other education-related expenses. And because home equity loans offer lower interest rates than most other types of loans, they can help you save money in the long run. So if you’re looking for a way to help pay for college, a home equity loan may be the right solution for you.

Worst Ways to Use Your Home Equity

  1. Buying a Car

Buying a car is one of the worst ways you can spend home equity money. Here’s why: First, cars are depreciating assets. They lose value as soon as you drive them off the lot, and they continue to lose value every year after that. So, if you use your home equity to buy a car, you’re essentially wasting that money. Second, interest rates on cars are usually fairly low, which means you might end up paying more in interest on a home equity loan than a car payment.

  1. Investing in the Stock Market

Another way not to use your home equity is to invest in the stock market. While it’s true that the stock market can offer the potential for high returns, it is also highly volatile. If the market crashes, you could find yourself owing more on your home than it’s worth. 

  1. Paying for a Wedding or Vacation

It’s no secret that weddings and vacations can be expensive. But when it comes to financing these big-ticket items, experts say you should steer clear of using home equity. Home equity loans or lines of credit can seem like an attractive option since they usually come with lower interest rates than other types of loans. However, there are a few potential pitfalls to consider before taking out a home equity loan to pay for a wedding or vacation. First and foremost, this type of loan is secured by your home, which means that you could lose your house if you can’t make the payments. In addition, home equity loans can take months or even years to pay off, which means you’ll be shelling out money for your wedding or vacation long after the event has passed.

Conclusion

Home equity can be a great way to finance a variety of expenses, including college tuition, investments, and even weddings or vacations. However, it’s important to use your home equity wisely, and avoid spending it on things like cars or the stock market. By using your home equity loan responsibly, you can save yourself money in the long run and ease the financial burden of some of life’s biggest expenses.

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