There’s no question that owning a home is a major responsibility that comes with significant challenges and expenses. Do you have a mortgage on your home that you’re still paying off? You may be able to take advantage of your home equity to maximize your financial gain from your assets. Your equity can be used to pay for major costs such as tuition, home renovations or an unexpected expense.
What is home equity and why does it matter?
Home equity is your house’s market value minus the remaining balance of your mortgage you have left to pay. Let’s say your home is currently worth $250,000, and you still have $100,000 of your mortgage to pay off. In this case, your home equity would be valued at $150,000. This value will increase as you pay off your mortgage or if the value of your home increases. You can take advantage of this asset by using it as security against a loan. Compared to other types of loans, a home equity loan gives you access to loans with relatively low interest rates. That said, you’ll want to borrow wisely. Did you know that you could lose your house if you find yourself unable to pay back your loan?
What types of home equity loans can I choose from?
Several options include refinancing your home, borrowing prepaid amounts or taking out a home equity line of credit (HELOC). The first option involves borrowing up to 80% of your home’s value. However, this amount is decreased by any remaining mortgage balance, HELOC or other loans secured by your home. You’ll then have to pay interest at a rate which may be different from that of your original mortgage. A different insurance premium may also apply to your new mortgage loan if you adjust the amount of your mortgage.
The second option listed above involves re-borrowing money you have already paid back on your mortgage. You can borrow the entire amount of the payments you have already made on your mortgage. A lump sum will be deposited right into your bank account. That said, don’t forget that you’ll have to pay it back along with the rest of your mortgage, plus interest. The interest rate you’re charged may be the same as that on your mortgage, or a blended rate. The latter is a combination of your current interest rate and a new rate. A HELOC also allows you to borrow money. In this case, you can borrow as often as you need up to a given credit limit. Once you pay it back you can borrow again.
Second mortgage options
Lastly, you can take out a second mortgage on your home. This allows you to borrow up to 80% of its appraised value minus the balance owed on your first mortgage. Keep in mind that interest rates on second mortgages are usually higher than those on initial mortgages. This is because they involve greater risk for the lender. Furthermore, you’ll have to pay off both mortgages simultaneously, increasing your chances of defaulting on your loan.
Don’t forget that you’ll also have to pay various administrative fees for the appraisal, the title search, legal services, etc. Fortunately, this doesn’t apply to borrowing on prepaid amounts. Another important consideration is your ability to pass a “stress test”, required for a refinanced mortgage or a second mortgage. This involves proving your ability to pay an interest rate that is higher than the one on your original mortgage. Lastly, remember that the more you pay off each month from what you’ve borrowed, the less interest you’ll pay.