Compare Your Home Borrowing Options »RealtyBizNews: Real Estate News
Your home equity is the difference between what you owe on your mortgage (s) and the current value of your home if you sell it today (appraised value). For example, if the remaining balance on your mortgage is $ 195,000 and the market value is $ 295,000, you have $ 100,000 in equity in your home. Your equity will increase in two ways. First, with monthly payments, you will receive equity by the amount by which the mortgage amount is reduced each month. Second, when the market value that you can sell increases, your equity increases. The two together determine the total equity that you have in your home.
It is not common and has not happened to many homeowners since the Great Recession, but your mortgage can be more than the value of your home. When you have more debt than the house can sell it is known as an underwater mortgage. It means that you have no equity in your home. This can also be done in two ways. First, the market value of the home can drop below the balance of the mortgage. Second, in theory, you could take out additional mortgage loans that, along with the original mortgage, exceed the market value of the loan.
You’ve probably heard that owning a home is one way of building wealth. The reason for this is that equity is an important financial tool that gives you financial opportunities that you would not otherwise have. One of the most common ways to use equity is to sell your current home to move into a larger, more expensive home.
But there are other ways you can make equity work for you. You can also borrow against your equity to pay for major home improvements or to consolidate other debts. Another option is to plan your retirement, which can be done in many ways. You could pay off the existing mortgage to own the home for free and freely so that you don’t have any mortgage or rent payments when you retire. The equity in your home can also be used to take out a reverse mortgage for retirement income. Another is to borrow against your equity to invest the money in something that pays a higher rate of return to increase the size of your retirement listing.
Your equity is like having money in the bank, but in most cases the only way to access it is by taking out borrowing.
Borrowing against your equity can be a smart way to borrow money as these loans come with the lowest interest rates and some tax breaks. Much lower than personal loan and credit card rates. This lower interest rate can save you a lot of money, especially on large ticket items that take years to pay out. However, borrowing money always comes with a risk, so do it wisely. Personal loans and credit card loans are unsecured debts. These loans could result in car repossession or bankruptcy, but your home shouldn’t be at risk. The risk with any type of home loan is that if you fail to make your payments, your lender could take your home through the foreclosure process.
Here are the 3 most common ways you can use your equity, along with tips to help you figure out which is best for your circumstances.
Home loan. This is also called the 2nd designatednd Mortgage. This can work well for people who want to keep their original loan exactly as it is. A home loan should be separated from the first loan. You will continue to make payments on the first loan and begin paying the new loan separately. One reason for this is that the second loan is a junior loan. If you default on the second loan, it will be more difficult for the lender to complete the foreclosure as they will have to repay the first loan. Home loans are better for those with a high credit score (700+) as they will get the best interest rate and will make it easier for them to qualify for the second loan. You receive all of the borrowed money at once and make a stable monthly payment. It also tends to be better for borrowers with less debt compared to their income.
Cash-out refinancing. This is a new loan that replaces the original loan. The new loan is for a higher amount. You will receive cash for the difference between the balance owed on the first loan and the higher amount owed on the new loan. If your first loan was for 30 years and the new loan has also been in use for 30 years, the loan repayment time will start over. But you could pay it off sooner if the new loan is 25, 20 or 15 years old. This new loan will be your first mortgage on your home and may be more prone to foreclosure in the event of a default. In general, you can expect your monthly payment to go up, but you will only make one monthly payment. Cash-out refinancing is usually easier to obtain for borrowers with lower credit scores (620+) and borrowers with higher levels of debt compared to their income.
Home Equity Line of Credit. This is also known as HELOC. As a line of credit, you only borrow the money when you need it. Your monthly payment increases as you borrow more money (similar to a credit card). Lenders offer home equity lines of credit in a number of ways, so it is important that you understand all of the loan terms (including the possibility of foreclosure). No loan plan is suitable for every homeowner. Contact different lenders, compare options, and choose the most suitable home equity line of credit for your needs. HELOC loans are usually better when you have unpredictable funding needs. Also for borrowers with higher credit ratings (700+) and lower levels of debt compared to their income.
Before deciding on any of these home ownership options, speak to a mortgage professional to fully understand the pros and cons of each option for you.
Please share your findings and experiences by leaving a comment.
Additionally, our weekly Ask Brian column welcomes questions from readers of all levels of real estate experience. Please email your questions, inquiries or article ideas to [email protected]
Author Biography: Brian Kline has been investing in real estate for more than 35 years and has been writing about real estate investing for 12 years. He also has over 30 years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives in Lake Cushman, Washington. A vacation destination near a national and Pacific ocean.