What is home equity?
Home equity or equity in a house refers to the difference between the balance on your mortgage and the market value of your home; it is the amount of your home that you own that is not encumbered by a first or second mortgage loan.
For example, if you do not have a mortgage, then you have 100% equity. If you have a mortgage, the lender "owns" part of your home. As you pay off your mortgage your equity (ownership) increases.
Read on to learn more about using the equity in your home.
At Credit Union of Southern California (CU SoCal), we make getting a Home Equity Line of Credit (HELOC) easy.
Call 866.287.6225 today to schedule a no-obligation consultation and learn about our home equity lines of credit, auto loans, personal loans, checking and savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all your banking needs.
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How does home equity work?
Home equity is the dollar amount or value of the home that you own based on how much you owe on your mortgage and any other secured loans that use your house as collateral.
As discussed earlier, if you
do not have a mortgage on your home then you 100% equity in the home. People who have a first and/or second mortgage own only a percentage of their home. The lender who holds the mortgage also owns a percentage of the home.
If you have a mortgage, as you make payments toward the principal amount owed (not the interest owed) your loan balance decreases and your equity increases until the mortgage is paid in full, and you have 100% equity.
Using the equity in your home gives you access to cash that can be used any way you choose.
How to calculate your home equity
To
calculate home equity, take the amount your property is currently worth, or the appraised value, and subtract the amount of any existing mortgages on your property.
For example: A home's appraised value is $600,000 – Amount owed on mortgage is $250,000 = $350,000 Equity.
How to take equity out of your home
Homeowners who have enough equity may consider using the equity in their home. The most common loans for getting equity out of your home are:
Home equity loan. Similar to a HELOC, a
home equity loan is based on the equity in your home. These loans have a fixed interest rate for the duration of the loan term. Interest is charged on the entire loan amount you've been given, whether you use the money or not.
Home equity line of credit (HELOC). A
Home Equity Line of Credit is a type of “revolving” credit, similar to a credit card. HELOCs come with a credit limit based on the amount the borrower is approved for. During the "draw period,” a variable interest rate is charged on the amount of the loan that's used. The draw period is followed by a repayment period when the loan converts to a fixed interest rate.
Learn more about how to take equity out of your home.
Best uses for home equity
Using the equity in your home can help you improve your financial position. Home equity loans are popular with homeowners because they have lower interest rates than credit cards and longer repayment terms. Here are some of the best uses for home equity:
Home improvements. Having money available through your home’s equity can help you increase the value of your home by using the funds to make improvements such as updating a kitchen and bathroom, installing new windows, and more.
Remove private mortgage insurance (PMI). If your home has appreciated in value, as most homes have these days, consider getting a new appraisal of the new market value. You may find you have 20% equity based on an increased market value plus the amount of the mortgage you’ve already paid off. Once 20% equity in the home is reached, you can request mortgage insurance removal.
Education costs. Use your home equity to get the degree you always wanted or pay for your child or spouse's education.
Debt consolidation. High interest credit card debt can cost thousands of dollars each year. Using a home equity loan to pay off credit card balances is one of the best uses for a HELOC.
Emergency expenses. A home equity loan can provide financial peace of mind when it's needed most. Use your
home equity as an emergency fund to pay for medical emergencies, medical bills, or unexpected home repairs
Business expenses. Entrepreneurs and small business owners often use home equity loans to start a business or fund an existing business. The interest rates on home equity loans may be lower than rates on small business loans.
Things to avoid
Having extra cash on hand can be tempting to spend. Using the equity in your home wisely is important to maintaining good credit and not putting your home at risk of foreclosure. Home equity is best spent on purchases that will increase your personal net worth and improve your financial position. Therefore, it's prudent to avoid spending your home equity on the following types of purchases:
Buying luxury goods. Using home equity to make luxury purchases such as vacations, jewelry, and items that do not in some way improve your financial position are not recommended.
Buying a car. Home equity interest rates are typically higher than vehicle loan interest rates and vehicles quickly depreciate in value, so using home equity to buy a new car is not the best use of home equity.
Investing. Using home equity to purchase risky investments, such as stocks, could result in lost money. However, some people use home equity to purchase an investment property or a
second home, which may increase in value.
Advantages of using your home equity
There are
home equity loan pros and cons as well as
HELOC pros and cons. Here are some of the advantages and disadvantages of using the equity in your home.
Lower interest rates. Home equity loans and HELOCs tend to have lower interest rates than credit cards and
personal loans.
Easier to obtain. Homeowners who are in a good financial position and have made on time payments of their current mortgage generally have an easy time getting approved for home equity loans.
Spending flexibility. The cash you get from a home equity loan or HELOCs can be used any way you choose.
Tax benefits. According to the
IRS, interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. The loan must be secured by the taxpayer’s main home or second home (qualified residence) and meet other requirements.
Disadvantages of using your home equity
These are some of the disadvantages of using the equity in your home to pay for expenses, compared to using a credit card, personal loan, or savings.
Fees. Home equity loans and HELOCs typically have a pre-payment penalty charged by the lender if you pay off and close your loan before the end of the specified term.
Your home will be used as collateral. If you default on the loan, the lender can take possession of the home through a foreclosure. Failure to make on-time monthly payments will also hurt your credit score.
Added debt. Taking on a large amount of new debt in the form of a home equity loan or HELOC can put a burden on your financial situation.
Risk of being underwater. If the value of your home decreases, you will lose equity and could owe the lender more than your home is worth. This is referred to as being "underwater."
How to increase your home equity
Pay down the principal
. Paying a little more each month toward the principal balance of the loan (not just the interest) decreases the total mortgage balance owed.
Wait for home value to rise. As your home value appreciates over time, your home equity will increase.
Make renovations. Making home improvements that increase your property value helps build equity. Projects that are particularly valuable include replacing the roof, windows, and doors for energy efficiency.
How quickly can you build equity in a home?
The time it takes to build equity in a home depends on your current mortgage loan amount and how much extra money you put toward paying down your loan amount. Economic factors, such as your home's market value, also affect equity.
Are there restrictions as to how I can use my home equity?
No, there aren't any restrictions. If you are approved for a home equity loan or HELOC you can use the money any way you choose.
How much equity can I borrow?
The amount of equity you can take out depends on the amount of equity you have. How to get equity out of your home starts with shopping for a lender, who will calculate how much equity you have and determine how much equity you can take out. The lender will also consider other factors in the loan application and approval process, including your past payment history, credit score, your debt-to-income ratio, and your home's loan-to-value ratio.
Is using my home equity worth it?
Using home equity to get cash has benefits, such as a lower interest rate than what is charged by credit cards. The main disadvantage of using home equity is that your home will be used as collateral to secure the loan. Failure to make on-time monthly payments will hurt your credit score. If you default on the loan, the lender can take possession of the home through a foreclosure.
How do home equity loans compare to HELOCs?
When it comes to home equity loans vs. HELOCs, there are some key differences to note. Home equity loans have a fixed interest rate that’s charged on the entire lump sum loan amount, whether the loan is used or not.
HELOCs are given as a line of credit that is only available for use during a draw period. These loans start with a variable interest rate that’s charged only on the amount of money that’s withdrawn. The variable rate converts to a fixed rate when the repayment period begins.
Why Savvy Consumers Choose CU SoCal
For over 60 years, CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!