We’ve all heard the phrase, “home is where the heart is,” but did you know that home is also “where the equity is”?
Simply put, home equity is the portion of your home that you’ve already paid for. If you’ve taken out a mortgage to finance the purchase of your home, it’s the value of your home, minus what you still have left on your mortgage. For example, if you own a $300,000 home, and still have $200,000 left on your mortgage, you have $100,000 of equity in your home.
And your home’s equity can sure come in handy when you need some extra cash for things like home improvements and renovations, college tuition, or paying down higher-interest debt.
Fortunately, there are a few different ways you can go about tapping into your home equity:
Simply put, home equity is the portion of your home that you’ve already paid for. If you’ve taken out a mortgage to finance the purchase of your home, it’s the value of your home, minus what you still have left on your mortgage. For example, if you own a $300,000 home, and still have $200,000 left on your mortgage, you have $100,000 of equity in your home.
And your home’s equity can sure come in handy when you need some extra cash for things like home improvements and renovations, college tuition, or paying down higher-interest debt.
Fortunately, there are a few different ways you can go about tapping into your home equity:
- Cash-out refinancing. With a cash-out refinance, you replace your current mortgage with a larger one, thereby giving you the opportunity to take the difference in cash. Basically, you’re obtaining a new mortgage in the amount of your existing mortgage plus the amount you want to borrow. The additional amount you want to borrow is, in essence, the home equity you’re tapping into.
For example, let’s say you initially took out a $240,000 mortgage to pay for a $300,000 home. At that time, you would have had $60,000 worth of equity in your home, or 20% equity. Now let’s say that after 10 years, you’ve paid your mortgage down and owe $170,000, and the value of your home has increased to $320,000. In this case, your home equity would now be $150,000, or 47%. With a cash-out refinance, you would take out a new mortgage in the amount of the $170,000 that you still owe, plus the money that you’d like to borrow as cash. So, if you need $10,000 for a bathroom remodel, you would take out a new mortgage for around $180,000. When determining how much of your equity to utilize in a cash-out refinance, it’s important to remember that if your refinance results in you having less than 20% equity in your home, you may be required to pay private mortgage insurance (PMI).
Also keep in mind that closing costs and fees could impact your cash-out amount. And you’ll need to negotiate a new term and repayment schedule for the new loan. Generally speaking, you can choose between an adjustable or fixed rate mortgage for a cash-out refinance, and depending on the term you select you could have up to 30 years to repay it. And your new mortgage will likely have a different interest rate than your existing one as well. So, if you currently have a very low interest rate on your mortgage, a cash-out refinance might not make sense for you if it means a higher rate than you’re paying now. But on the flip side, if your new loan has a lower interest rate than what you’re currently paying, a cash-out refinance could provide the cash you need and save you money on interest at the same time. - A home equity loan. A home equity loan is sometimes referred to as a “second mortgage”. This is because a home equity loan is in addition to your main, or “first”, mortgage. With this type of loan, you borrow a specific amount of money, and you receive it in a lump sum and pay it back with a flat monthly payment over the course of several years, usually at a fixed interest rate. Because you’re getting a second mortgage, you’ll have two mortgage payments to make each month.
When applying for a home equity loan, the lender will evaluate your home’s current market value, and then offer a maximum amount that you can borrow based on the amount of equity you have in the home. - A home equity line of credit. A home equity line of credit, or HELOC, allows you to tap into your home’s equity, up to a certain amount, as needed during a designated “draw period”. Similar to a credit card, as you pay off the amount borrowed, you can use the available credit again. The draw period with a HELOC typically lasts between 5 and 10 years, depending on the terms of your loan. During the draw period you make modest repayments on the amounts you borrow. Once the draw period expires, you enter the “repayment period” where you make more substantial repayments. The repayment period typically lasts 15 years or so.
Unlike a home equity loan, which has a fixed interest rate, a home equity line of credit typically has a variable interest rate, meaning it can change throughout the loan’s term. Because of this, your payments will vary each month depending on your current interest rate, the amount you currently owe on the line of credit, and whether you’re in the draw or repayment period.
A HELOC can be a great way to borrow against your home’s equity on an “as needed” basis, but with that kind of convenience you’ll need to avoid the temptation of using it for everyday expenses, or to buy things you really don’t need. While a home equity line of credit can seem similar to a credit card, you should keep in mind that your home serves as collateral for the money you’re borrowing. If you don’t pay the loan back, your home is on the line.