By: Alix Langone
Tappable home equity across the country remains abundant, with average equity per borrower at nearly $300,000. That gives homeowners an advantage when it comes to borrowing money as interest rates continue to hover near 20-year highs.
Unlocking your home’s equity can be a smart way to access cash at a lower interest rate than other types of financing when rates are high.
How does home equity work and why use it?
Home equity is simply the difference between what you owe on your mortgage and the current value of your home. As you make mortgage payments over the years, the equity in your home increases because you’ve paid off a higher percentage of your loan. It can be worth taking equity out of your house to tackle important life expenses that you don’t have the cash to cover.
Taking a loan out against your home equity means taking out a second mortgage on your property. When borrowing against your house, most lenders want to see that you’ve accrued at least 15% to 20% of equity, which takes a typical homebuyer five to 10 years to accumulate. You can unlock your property’s equity through a home equity loan, a home equity line of credit, or HELOC, or a cash-out refinance.
Home equity loans require putting your house up as collateral to secure your second mortgage, so you should carefully consider the types of expenses that are worth the risk of foreclosure if you can’t make payments.
5 reasons to use a home equity loan
There are a number of reasons to use a home equity loan and when it comes to your largest asset, you must first decide what makes the most sense for your specific financial situation. If, for example, you have a pile of high-interest consumer debt, such as credit card debt, a home equity loan will allow you to immediately pay it off at a much lower interest rate, as well as give you the flexibility to pay it off for up to 20 years, while saving you thousands of dollars in the process.
Here are five reasons to use home equity.
1. Home renovations or improvements
The biggest benefit of completing home renovations with a home equity loan is that your interest is tax deductible, which gives you valuable savings. Plus, you get to enjoy living in your newly improved home, while increasing its overall value, and ultimately what you can sell it for down the line.
2. Consolidating high-interest debt
If you have credit card debt with high interest that makes it hard to pay down, it may make sense to use a home equity loan to pay off your balances at a lower interest rate, saving you thousands of dollars in interest. Currently, interest rates for a HELOC and a home equity loan are under 8%, respectively, according to CNET’s sister site Bankrate. Compare that with the interest rates of credit cards, which can range from 15% to 29% (the average rate for a new credit card is 18%).
3. Higher education costs
College tuition is one of the largest expenses facing families today and home equity loans can help provide upfront funds over an extended period of time.
4. Unexpected emergencies
If an event that’s out of your control cripples your finances, such as an unplanned medical expense, a home equity loan is one option to consider. But first, it’s worth asking the business, hospital or creditor if you can go on a payment plan. If a payment plan is an option, then you don’t need to put your house at risk by taking out a loan.
5. Business related expenses
Using a home equity loan to reinvest in your business, or start a new business, can pay off if handled responsibility. It’s an option to consider if you’ve evaluated the health of your business, have a fully fleshed out business plan and know what you’ll do if you run out of funds for your business but still need to pay back your loan.
Factors to consider before taking out a home equity loan
- The value of your property can decline: While home prices soared over the past two years, the housing market is slowing in response to rising mortgage rates and inflation. You can end up “underwater” on your mortgage when what you owe on your home ends up being greater than the value of the property itself.
- There are limits to how much you can borrow: Your bank or lender will typically allow you to take out 75% to 90% of your home’s loan-to-value, or LTV, ratio, which is your outstanding mortgage balance divided by your home’s current value. Make sure you can borrow enough to cover your needs.
- Use your loan responsibly: If you’re one who’ll be tempted to spend your influx of cash on nonessential items, such as a vacation or a new car, think twice before signing off on a home equity loan. For example, if the intended purpose for the loan is to fund for home improvement projects that will enhance the value of your home, don’t give in to discretionary temptations and use the money for superfluous expenses.