How to Leverage the Equity in Your Home
Is inflation putting too much strain on your budget or do you have a large expense coming up that your savings just can’t cover? Leveraging the available equity in your home can be an easy way to improve your financial health.
Recent data shows that the amount of tappable equity across U.S. households grew by $2.6 trillion in 2021, with the average homeowner having about $185,000 built-up (CNBC).
With all the extra equity, many homeowners like yourself have considered accessing this “forced savings account” to help get the cash needed to strengthen their budget or pay for large-scale projects, all without selling their homes.
If you need some extra funds for home improvements, want to start a business, or have some other purposes that require a heftier sum of money, here are a few ways to pay for those goals by leveraging the equity accrued in your home.
What is the Best Way to Access Your Home Equity?
Before you can leverage your home equity for financial advantage, it's important to identify just how much equity you have access to.
Figuring out how much equity you have available is as simple as taking your property’s current market value and subtracting any mortgage balance you might owe that's outstanding (MyHome).
Once you know how much equity you have available, there are a few common ways to pull that equity out of your home. Since everyone has different financial needs, it's important to understand all your options to make the best financial decision for your situation.
Option 1 - Home Equity Loan
If you have ever heard a person use the phrase “second mortgage” they were probably referring to a home equity loan. The reason why they are known in this way is that they typically take a second lien position on your home (behind your primary mortgage).
Home equity loans can be structured in a variety of ways but normally they have a fixed loan amount and term. This means that your payment consists of both principal and interest and the initial funds are paid out to you in one lump sum that can be used to finance your financial goals.
Like a traditional mortgage, some lenders may require a full appraisal inspection before approving you for a home equity loan, however, the overall total credit costs are reliably cheaper.
Option 2 - Home Equity Line of Credit
Another tool you can use to leverage the equity in your home is by taking out a home equity line of credit (HELOC). A home equity loan and HELOC are in some ways very similar. They are both traditionally thought of as second mortgages, easier to qualify for, and are often cheaper sources of financing than many first mortgage products.
However, the main difference is that a home equity line of credit is revolving, meaning you can use it, pay it down, and use it again. It works sort of like a credit card, but instead of being unsecured, your home is the collateral backing the loan.
Many homeowners find HELOCs preferable because they offer a lot of flexibility. They also typically have interest-only repayment requirements. One downside is that HELOCs usually have an adjustable interest rate meaning your payment can go up or down depending on market conditions.
Option 3 - Cash-Out Refinance
An alternative to using a home equity loan or line of credit is completing a cash-out refinance of your primary home mortgage. This involves using a higher loan amount than what you owe on your home, paying off your existing mortgage, and receiving the remaining funds at closing.
Cash-out refinances can be advantageous if you are looking to secure a lower rate over a longer period. It's also a good idea if you want to consolidate everything into one monthly payment.
However, there are a few drawbacks to using a cash-out refinance. The first drawback is that you must go through a more extensive application and qualification process. Additionally, there can be greater restrictions on how much equity you can leverage, and, comparatively, closing costs can be higher.
Conclusion
Investing in real estate is not an overnight success story, but building equity in real estate is a gift that keeps giving. When you invest in real estate and hold it for the long term, the value it can add to your portfolio is great due to the way you can leverage its equity.
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