Home equity is typically a homeowner’s most valuable asset. Building home equity is important, but thankfully, it really isn’t that complicated. Pay down a significant amount of your mortgage and you’ll have an equally significant amount of home equity. You’ll also have an extra measure of financial freedom. You can borrow against this equity to help pay for just about anything you want, like your children's college education, a major kitchen remodel, or to pay off your high-interest rate credit cards.
It’s easy to see how the equity in your home could help make dreams come true. However, it’s possible to misuse your home equity. After all, home equity lines of credit use your home as collateral. This means that if you miss payments, your lender could take your home from you.
Fortunately, using home equity wisely just takes a bit of good financial sense.
Using Your Home Equity
A home equity line of credit works like a credit card. Your existing home equity determines the amount of credit available to you. You can then borrow up to that maximum line of credit as often as you like. You do, though, have to pay back the amount of money you borrowed, with interest. Let’s say you have a home equity line of credit of $100,000, and you borrow $10,000 to pay for a bathroom renovation, you'll have to pay back that $10,000 in monthly installments. However, you’ll still be able to borrow up to $90,000 more before maxing out your credit. You’ll have approximately 10 years to draw down on the line of credit. After 10 years, the draw option will end and any outstanding balance will be due, with interest, and amortized over a 20-year repayment period.
Naturally, some uses of home equity are better than others.
People often use the funds from a home equity line of credit to pay for a major home improvement project. Smart move, because if you improve your home, you'll also be increasing its value. This in turn, boosts the amount of equity you have in your residence.
However, consider investing in a home-improvement project that actually boosts your home's value. Kitchen updates and the addition of bathrooms or master bedrooms usually add to the value of a home. Certain cosmetic changes such as new carpeting or landscaping might not.
Often, it makes smart financial sense to use a home equity line of credit to pay off your credit card debt. That is because the interest rates attached to home equity lines of credit are usually far lower than are the ones that come with credit cards. It’s better to pay back a $50,000 home equity loan with a rate of six percent than credit card debt with a rate of 17 percent, a figure not overly high for standard credit cards.
It might also make sense to use your home equity to make an investment that will pay off for you down the road. For example, some homeowners might tap into their home's equity to invest in a rental property that will both generate monthly rental income and, hopefully, grow in value over the years.
As powerful a tool as home equity can be, there are potential drawbacks. In the worst-case scenario, if you cannot make your payments on a home equity line of credit, your lender could take your home. So only borrow against your home equity if you are certain that you'll be able to pay back the loan on time.
Have other questions about a home equity line of credit from Liberty Bank? You’ll find everything you need to know right here.