3 ways to use your home equity
Three ways to tap the equity in your home
If you’re wondering where to get the funds for a large purchase, like a new roof or kitchen remodel, consider tapping into the equity in your home.
There are three ways to leverage your home’s equity: home equity loans, home equity lines of credit and a cash-out refinance loan. There are differences between these financial products, but they all share one feature: Your home is the collateral which secures the loan. This is important to remember because, if for any reason you are unable to repay the loan as agreed, you could lose your home.
In addition to using your home as collateral, the three loans discussed below share other features.
- None of them are free; you may incur costs when closing on any home loan.
- The interest may be tax deductible. (Consult your tax preparer.)
- How you spend the money is up to you.
Home equity loan
Equity is the difference between what your home might reasonably sell for and what you owe on the mortgage. If that difference is greater than zero, you could potentially borrow some of the equity.
A home equity loan (sometimes called a second mortgage) is similar to an auto loan. You apply for the loan, and – once approved – you will receive a lump sum payment to spend as you please. Like an auto loan, home equity loans have a fixed interest rate and a fixed term. You will make regular, monthly payments (principal and interest) on the loan until it’s repaid.
There can be closing costs associated with a home equity loan. These will be similar to the types of closing costs you paid when you applied for your original home loan.
Home equity line of credit (HELOC)
HELOCs and home equity loans are similar in that you’re borrowing against your home equity. But whereas a loan typically gives you a sum of money all at once, a HELOC is more like a credit card: You have a certain amount of money available to borrow and repay, but you can take what you need as you need it. Once you have borrowed an amount and repaid it, those funds “revolve” back into the credit limit and are available to you again. As a result, your minimum monthly payment will fluctuate just as it does with a credit card.
A line of credit may also has a variable interest rate like a credit card, but unlike a credit card, you have a pre-determined period of time to advance your line of credit (a draw period). Payments required during the draw period are typically interest only. Once the draw period has ended, you must pay back the principal and interest – if any are due – in regular, monthly payments (principal and interest), similar to an auto loan.
HELOCs can have lower closing costs as compared to home equity loans or refinance loans, and you pay only on the funds you have advanced, which makes these lines of credit a good choice for many people. Just be mindful that the interest rate can fluctuate with the market.
Refinancing is the process of obtaining a new mortgage to reduce monthly payments, lower interest rates, take cash out of your home, remove Private Mortgage Insurance or change mortgage lenders. A cash-out refinance allows you to use the equity in your home for a variety of purposes such as buy a new car, pay tuition, make home improvements and consolidate debt. Cash-out mortgage transactions are not only easy, they may also be tax deductible.