Building equity in your home, the difference between a home’s fair market value and the outstanding mortgage balance, is every homeowner’s goal. After all, it is the whole point of buying a property vs. renting it. Home equity is valuable savings, but it can also be a valuable finance tool.
Homeowners who have equity in their homes have the option to borrow money against that equity as a loan or line of credit. It is important to note that the home is used as collateral against the debt, so making sure you can pay back the money is vital as the creditor can seize the home if the owner can no longer make the payments on the loan. Many lenders require the homeowner to keep at least 20% equity in the home due to fluctuations in the market prices, another important detail to keep in mind.
You may tap into your home’s equity for a variety of reasons, but some uses aren’t necessarily the best options or a smart financial move. Home equity is a valued resource, and you don’t want to put your house at risk using it for the wrong reason, but there are some situations where it makes great financial sense. To help you sort out the confusion, we’ve provided some common home equity do’s and don’ts:
- Don’t use your equity to fund your lifestyle. If you are living outside your means now, pulling the equity out of your home to continue living that lifestyle will probably end badly. Look at your home’s equity as an investment, not a source of cash. If you can’t afford to buy a boat, RV, second home, etc. on your income now, how can you expect to pay back the money you borrowed to purchase them to begin with?
- Do use it for home improvements. One of the best uses for the equity in your home is to put it back into the home. A kitchen or bath upgrade, new roof, or an outdoor entertaining space can add value to your home and help your resale value. A loan may make more sense for a one-time project, like those listed above, but a line of credit may make more sense to fund ongoing home improvement projects that you may do over time.
- Don’t use the equity to pay for basic expenses. Groceries, utilities, clothing, etc. should all be part of your monthly budget and shouldn’t require using the equity in your home to fund them. Set a budget that you can afford and stick to it.
- Do use equity to consolidate debt. High interest credit cards and multiple loans or lines make perfect sense to consolidate and pay off with the equity of your home if the numbers make sense. If you are paying out a lot of money each month in interest and can secure an equity loan at a lower rate, you can save money by consolidating! It also makes life simpler with just paying one bill. HOWEVER, you need to make sure you don’t rack up balances on your accounts again otherwise you’ll be in worse shape than before.
- Don’t finance college if you can avoid it. It seems like a good idea to use your equity to pay for higher education vs. taking on student loans, but it may not be for everyone. As you get older, having a lot of equity in your home and paying it off is usually part of your retirement plan. Using your equity to finance college could set back your retirement plan and jeopardize your financial security.
- Do use it for an emergency. You can’t plan when or even if an emergency will happen but knowing that you have equity in your home for such a case can help you sleep better at night. An unexpected surgery or medical issue or even having to replace a sewer or water line that you didn’t plan for can happen at any time. Having the equity in your home to cover these 1-time expenses can make the difference between losing your home or taking on mounds of credit card debt.
Regardless of why you are taking out a loan or line of credit against your home’s equity, you should be aware of your rights as a borrower. Make sure you keep records of all the loan/credit documents. If you are using the money for home improvements, always get references and several estimates. Consider all the costs of financing before you sign on the dotted line. We always urge our clients to consult with a financial advisor and or an accountant before making any large financial decisions. If you have any questions about Home Equity Loans or Lines of Credit, we’re here to help – give us a call!
Vice President, Senior Mortgage Lender
NMLS MLO ID: 532621