Home equity lending is a busy scene at the moment. House values have skyrocketed in recent years and owners who kept up with their mortgage are now sitting on a healthy cushion of equity. Yet for many, being house rich is not the same as being cash rich. This is where financial products come in — to help homeowners capitalize on property wealth and turn paper gains into funding for their next big project.
But tapping equity essentially involves putting your house on the line — is this really a smart move?
Ways to access home equity
Home equity is the difference between the value of your house today and what you still owe on your mortgage. If the market value of your house is $200,000 and you have $80,000 outstanding on your home loan, then your home equity is $120,000.
You can access your home equity in the following ways:
Cash-out refinance
Home equity loan
HELOC
A key advantage of borrowing against your equity is that it’ll cost you less — way less in many cases. These loan alternatives are secured against your home, so lenders can offer lower rates compared to credit cards and personal loans because they face lower default risk to the lender.
Cash-out refinance
Also called a cash-back mortgage, cash-out refi involves refinancing your home for a larger amount than your mortgage balance, which allows you to take the difference in cash. If your current mortgage balance is $80,000 and you refinance your mortgage for $90,000, then you’ll receive $10,000.
A cash-out refinance replaces your existing home loan with a new one, and can be advantageous if you can secure a lower refinancing rate than what you’re currently paying. However, closing costs for this type of loan are high — typically 3% to 5% of the loan amount. With interest rates going up, you could also end up with bigger monthly repayments.
Home equity loan
A home equity installment loan allows you to keep the low rate on your existing mortgage and take out a second loan against the equity you’ve built. It’s ideal if you know exactly how much you need to borrow from the outset and prefer a predictable repayment schedule. This type of loan can be a good option for things like buying a car or replacing appliances and furniture, but bear in mind there are closing costs.
HELOC
A traditional bank home equity line of credit or HELOC works like a credit card. You’re approved for a spending limit and you can take money out as needed up to your approved limit during the draw period. Whatever you pay back on the HELOC during the draw period replenishes your credit so it’s available again for use.
Typically, the draw period lasts five to 10 years and you’ll make interest-only repayments during this time. The amount outstanding at the end becomes a loan you’ll pay back during the repayment period over the next 10 to 20 years.
Compared to the other two options, HELOCs offer greater flexibility — you don’t have to know costs upfront or when you might need the funds. You’ll only pay interest on what you use and there are no closing costs either.
What can you use home equity for?
Home equity loans and particularly HELOCs, are often used in the following ways:
Home renovations. You could qualify for tax deductions on interest payments if you’re using the loan to make substantial improvements to your home.
Rainy day fund. Whether you’re facing unexpected illness, job loss, divorce or emergency repairs, accessing home equity can help you stay afloat.
Paying off debt. Since interest rates on home equity borrowing tend to be much lower, it can make financial sense to swap high interest rate debt with a low-rate home equity loan.
Paying for college. While you might qualify for federal aid to put your kids through college, you’ll likely face significant funding gaps once you take annual loan limits into account. Alternatives like PLUS loans and private loans are unsecured — and therefore more expensive.
Starting a business. A great way to get your business off the ground quickly, lenders won’t demand thorough business plans and financial projections when you apply for a home equity line or credit or installment loan.
With so many different ways to take advantage of cheaper borrowing, there’s a danger of using it too much — and for the wrong things.
When is it a bad idea to use home equity?
One way to separate money well spent from unnecessary outgoings is to look at impact on wealth.
Using home equity for items that hold or even appreciate in value — like home remodeling — can result in greater wealth. The same is true for debt consolidation because it allows you to lower overall interest payments.
Conversely, buying depreciable assets like cars, boats, jewelry, computers, and electronics is likely to reduce your long-term wealth.
Of course, things aren’t always so black and white. For example, paying for your kids to go to college is a good investment to improve their future earning potential, but that might not add to your long-term financial wellbeing. And what about that vacation you’ve been dreaming about for years? There are no easy answers, but it’s important to remember that you’re putting your home on the line, and whatever you’re tapping equity for, you’ll be paying it back over a long time.
How much equity can I draw?
Lenders vary in their requirements but generally, most require you to keep around 20% of equity in your home. But if you have strong credit, you may be able to borrow more. Lenders use the Combined Loan To Value ratio, or CLTV, to check the size of the new loan you can take on given the equity they require you to keep.
If your property is worth $200,000, keeping 20% of equity means you can borrow a maximum of 80% of its value, which is $160,000. Let’s say your current mortgage balance is $80,000 and there are no other claims against your house — then you can borrow a further $80,000 before reaching the $160,000 limit.
In this instance, a CLTV cap of 80% means you can only borrow an additional $80,000 on top of your current mortgage, even though the value of your equity is $120,000.
How a HELOC from Figure works
Figure's HELOC works a little differently than what was described here. Figure’s HELOCs are start from $20,000 and go up to $400,000, with loan terms ranging from five to 30 years.1navigates to numbered disclaimer
While many HELOCs have variable interest rates, Figure offers fixed2navigates to numbered disclaimer rates. The rate applied to each draw is fixed at the time the draw is made. If the interest rate goes up, then a higher rate will only apply to new draws and not your existing balance.
Figure doesn’t charge account opening and maintenance fees or prepayment penalties. You’ll just have to pay an origination fee3navigates to numbered disclaimer to cover the cost of providing the loan. With the application process 100% online, you could apply in minutes and secure the funds you need in as little as five days.4navigates to numbered disclaimer
Turn your home equity into cash with a Figure HELOC today!
