Your Home Equity
Equity is the difference between a home’s market value and the amount that is still owed on it. It can be a great thing for homeowners, as it allows for extra money to invest in things like renovations. There are two ways to borrow against your equity — loans and lines of credit. Either one has its benefits and risks, but the more important thing to know when it comes to home equity is what exactly you’re borrowing the money for.
There are responsible ways to use equity, and there are irresponsible ways. It’s important to have an understanding of why using equity responsible is so crucial to financial stability and growth.
Don’t Be Impulsive
It’s very easy to look at equity as free money and therefore use it for frivolous spending and irresponsible investments. The key is to not be impulsive with your equity loan or line of credit, and to plan for whatever it is you’re doing with the money.
The best way to use your equity might not necessarily be a family vacation to Mexico or a shopping spree, as that money could be put into more worthwhile investments like home renovations or even debt consolidation.
Try to avoid impulsively spending your equity and be sure that you’re making the right choice in the long run.
Investing in the right things as a homeowner will not only put your equity to good use, but could lead to even bigger payoffs in the future. The first thing to remember is the bigger the down payment, the more equity you’ll ultimately build. Even a 20 percent down payment can give you lots of equity as soon as you start making payments on your mortgage.
Using your equity for home renovations might just be the smartest use of the money, as you’re putting it towards something that can increase the home’s value and therefore give you more equity the next time it’s appraised.
Another benefit to using your equity for renovations is that when you sell your home eventually, you stand a chance of profiting more on it because you’ll have increased the value.
Loan Or Line Of Credit?
When it comes to equity, choosing between a home equity loan or a home equity line of credit (HELOC) essentially comes down to what exactly you’re using the money for and what makes sense for you as a homeowner. Home equity loans just that — loans. They’re not flexible lines of credit that can be paid down and used up again. Once your loan is paid, it’s paid.
These loans are also called second mortgages, and typically have fixed interest rates that are generally higher than the first mortgage. Home equity loans are a good fit for those who are looking to pay for college, consolidate debt or pay for medical expenses.
HELOCs are more flexible than the other option, as the homeowner has the ability to draw from it and pay it down continuously, just like you would a credit card. The best use of a HELOC is for expenses that occur periodically over time rather than one large expense. This is the cheapest option, as you only pay interest on what you owe and don’t pay closing costs.
There is a third option for using equity that isn’t in the form of a loan or line of credit. This option is called cash out refinancing. What it involves is the homeowner refinancing their home for a larger amount and then taking the difference in cash.
This option may be good for paying off loans or credit cards, or if you’re in a position where you’ve accrued a good amount of equity and need cash but qualify to get a better rate on your first mortgage. Always use caution here, you’ve worked hard to build that home equity up.