Everything You Need to Know About Home Equity
Home equity is important, because you can borrow against this money to improve your home, raise your property value or pay off a debt with high interest.
Looking for a way to finance your home renovation or consolidate your debt? Using your home equity could be the best option for you. Here’s everything you should know about home equity:
What is home equity?
Simply put, home equity is the difference between the current market value of your home and the amount you owe on your mortgage. For example, if your home is worth $250,000 and you owe $150,000 on your mortgage, you have $100,000 worth of equity in your home.
Equity increases as you pay down your mortgage and can also increase as your home becomes worth more. If your home’s value decreases faster than the rate at which you pay the balance on your mortgage, your home equity could fall.
Here’s how it works
Home equity is important, because you can use it to borrow against this money to improve your home, raise your property value or pay off a debt with high interest. You’ll also be able to use your equity for loans or home equity lines of credit (HELOCs).
Home equity is commonly used for:
Debt consolidation
Home improvement
Paying credit card balances
Student loans
Investments
Home equity loans and lines of credit (HELOCs)
Home equity loan
When you qualify for a traditional home equity loan, the bank pays you the full amount at one time. You repay the loan through monthly payments with a fixed interest rate. Home equity loans are often referred to as second mortgages, because your home serves as collateral for the loan.
HELOC
A HELOC is comparable to a credit card. You receive a line of credit with a cap on the amount you can borrow, along with an adjustable interest rate. During the initial period (usually 10 years), you can withdraw as much as you’d like within your credit limit.
As you pay back your balance, your credit will revolve, allowing you to use it again. After your initial draw period, you will owe the remaining interest and balance. Typical repayment periods range from 10 to 20 years.
Home equity vs. HELOC: which is better?
What do you plan to use it for? Home equity loans are better for a large project with a fixed cost. A HELOC offers more flexibility, as you can borrow as much or as little as you want. This makes the HELOC better for smaller or recurring purchases.
If you want a consistent repayment option, choose the home equity loan. Your payments will stay the same. With HELOCs, your payments will fluctuate each month. If you can afford variable payments, a HELOC might be a better option.
Should I get a home equity loan?
Consider the benefits and disadvantages of home equity loans before applying with a lender.
Benefits
Home equity loans come with two major advantages: lower interest rates and tax benefits. These types of loans have lower interest rates than credit cards or personal loans. You can also deduct the mortgage interest on home equity loans or lines of credit, depending on how you use the money. Capital improvements or improvements to “buy, build or substantially improve” your home can qualify for deductions.
Disadvantages
As with any type of loan, home equity loans bring certain disadvantages, such as borrowing cost or the risk of home loss. Depending on your lender, you may owe a fee for taking out a home equity loan or HELOC. You may also pay additional fees for your application, appraisal, credit report, and title search and insurance.
By taking out a home equity loan, you could risk losing your home. The amount you owe is secured by your home, and your home serves as collateral on the loan. If you fail to make proper payments, your lender could foreclose on your home. If the value of real estate drops, you could end up owing more on your home than it’s worth.
Do I qualify for a home equity loan?
Here’s what most lenders require, according to NerdWallet:
A credit score of 620+
A loan-to-value ratio (LTV) of 80%
A debt-to-income ratio lower than 43%
Good credit history
These factors help lenders determine whether you’ll be able to repay the loan. Lenders reject applications for two main reasons: poor credit history and too little home equity. By meeting the above requirements, your application should sail through the loan application process.
When should I use my home equity?
Whether determining whether you should get a home equity loan or line of credit, prioritize your needs over wants. Home equity should be used only to pay for items that will increase your wealth. These include renovating your home, paying for higher education or launching a business. In other words, you should strive to use home equity for “good debt” purchases. Read more about how to tell the difference between good and bad debt here.
Ready to design and build the custom home of your dreams? Get in touch with Atmos today!
