Many of the nation’s homeowners are finding themselves with more equity in their homes than anticipated, largely due to rising home prices. Many are mulling borrowing against that cash through a home equity line of credit, a home equity loan, or a refinance debt consolidation loan.
Basically, there’s money in your house – but should you use it?
The Issue
Inflation and interest rates have been up of late, prompting many homeowners to transform some of their newly discovered equity into cash to lower credit card or other high-interest debt. You must decide whether this is the right move for you.
What is Home Equity?
Home equity is the difference between the amount you owe your lender and what your home is worth. As your loan balance decreases, the amount of equity you have grows. Equity also grows commensurate with your home’s value. One-hundred-percent equity is when your mortgage and any other loans secured by your home are fully paid.
Tapping into Home Equity
There are multiple ways to get cash out of your home equity:
Cash-Out Refinance
To lower monthly borrowing costs and save money on total debt payments, some homeowners seek a debt consolidation refinance. Those who do often use what’s called a cash-out refinance loan. This kind of loan uses your home equity to increase your mortgage balance, which provides the cash. The money can be used however you wish, including to consolidate high-interest debt.
Home Equity Loan
Considered a second mortgage, a home equity loan permits you to borrow a lump sum of up to 85% of your home equity. You’ll make monthly payments over a fixed term ranging from five to 30 years. Your interest rate is fixed, too, which helps ensure a known repayment schedule. Further, you interest cost may be tax deductible, but you’ll need to check with your financial advisor.
Secured by your property, the loan can be used to consolidate debt or for large expenses such as a vehicle or home improvement.
Home Equity Line of Credit (HELOC)
Also considered a second mortgage that’s secured by your home, a HELOC gives you a revolving credit line to consolidate high-interest debt or for big purchases. As you pay down your balance, the amount of credit available to you increases, much like how a credit card works. You’ll usually get a lower interest rate with a HELOC than you would with a personal loan or other common loan types.
You can likely borrow up to 85% of your home’s value, less your balance. You’ll typically have a “draw period” of 10 years during which you can borrow as much, or as little, against your available equity as you wish, up to your credit limit.
When the draw period ends, the repayment period of about 20 years begins. Your interest rate will likely be variable, although some lenders will permit conversion of part of your HELOC balance to a fixed rate.
Should I Take Advantage of My Home Equity?
There are some things to consider before tapping your home’s equity:
- Your home will serve as collateral. Yes, you could wind up losing your home if you don’t keep up with payments.
- Your loan could get pricey. Interest rates have been on the rise, and if that continues, your adjustable-rate loan interest rate could rise as well.
- Origination fees. Such loan processing fees will range between 2% to 5% of the total you’re borrowing.
Whether you should use the money you have in your home will depend on your situation, your stomach for risk, and other factors, including your reasons for seeking a loan.