Over 65% of Americans own homes and get to reap the benefits of homeownership, while many renters are saving up for homeownership because they recognize the overwhelming advantages of owning a home. Monthly mortgage payments will eventually go away as you continue making loan payments, while renters make monthly payments without building equity. While you can get closer to becoming debt-free with every monthly payment, all of those payments provide another benefit.
Homeowners can also use their properties as extra funding sources via home equity. Your down payments, monthly mortgage payments, and home appreciation increase your home equity. Some homeowners may feel nervous about borrowing against this equity since this strategy increases their debt. However, having that extra option provides more financial flexibility and can come in handy.
When Should You Borrow from Your Home’s Equity?
While homeowners shouldn’t rush to borrow from their home’s equity, it can be the right move for some purchases and investments. Tapping into home equity provides a sudden boost in capital that can cover financial shortcomings. It can relieve your stress and give you time to accumulate additional funds. You get the money for an important expense immediately and can repay it gradually.
Homeowners can save enough money for these expenses, but some purchases and investments only present themselves for a limited time. Waiting to accumulate enough money can result in missed opportunities and experiences. You may miss out on a great investment or a wonderful getaway by accumulating funds without considering your home’s equity. You might also have an emergency expense that exceeds what you have in your bank account. Home equity lets you cover these emergencies. If the emergency centers around a home repair, borrowing against your home’s equity can increase the property’s value in the long run.
Before getting a home equity loan, a lender will review your credit score, debt-to-income ratio, and the loan-to-value ratio. It’s important to keep this in mind even if you don’t want to use your home equity right away because these metrics will impact your ability to borrow against your home equity in the future. Homeowners who aren’t in emergency scenarios tend to wait a few months to build up these numbers before approaching lenders. In addition, most lenders only let you borrow up to 80% of your home’s value across your mortgages and provide a lump sum. However, you can get your loan-to-value ratio up to 95% with some mortgage lenders.
7 Common Ways to Use Your Home Equity
Homeowners can use their home equity in any way they desire. You don’t have to tell the bank how you plan on using your second mortgage. However, most people use a home equity line of credit or another financing method for one of these common reasons.
1. Buy a New Home
A home equity loan can provide enough financing to afford a new home. Some people use a home equity loan to buy a second home, but it’s also common to see home equity loans in action during transitions. Some homeowners will find their next home before finalizing a deal on their current home. You don’t want to miss out on your next home because you don’t have the proceeds yet from your old home—most homeowners who are making a move plan to sell their current homes. You can utilize your home equity to purchase the new home and give yourself enough money to cover a few mortgage payments.
Taking out enough equity makes two mortgage payments more doable until you find someone to buy your current home. If you are buying a second home, you can use home equity to cover the down payment and then manage both mortgage payments. Without home equity, it can take several years to save enough money for a down payment. You may lose out on great opportunities and watch prices rise if you wait too long. Appreciation may outpace your ability to save for another home if you don’t tap into your current property’s equity. Home equity accelerates your path to a second home or a new property. You get additional funds that can be the decisive factor between owning a second home and never reaching that milestone.
2. Use It for Your Retirement
People work for several decades and save some money to prepare for retirement. As you continue working and saving for retirement, the value of your home will go up. A portfolio can provide cash flow, but a homeowner short on cash can consider taking out a home equity loan. A home equity line of credit lets you borrow against your home without making fixed monthly payments. Some people hope the home equity loan outlives them. Then, their heirs get the home and can pay off the home equity loan by selling the house.
The only risk with this strategy is if you outlive your home equity payouts. If borrowers get too comfortable with these payments and don’t have a backup plan, they can become financially distressed. At this stage of their lives, borrowers tend to be much older and may have a more difficult time securing a job. Your home’s value should continue increasing to compensate for this scenario, and a HELOC’s draw period extends how long you can get away with low payments.
However, running out of funds is an important risk to keep in mind. At this point, you will have a high loan-to-value ratio for your home and may have difficulty getting additional financing. Even if you get funds, you may have to contend with a higher interest rate due to an unfavorable debt-to-income ratio. You will then need an additional funding source and have high debt. Most people have limited income options by the time they have exhausted home equity during their retirement years.
3. Repair or Renovate Your Home
Homes endure wear and tear over the years and lose some of their functionality. Some homeowners replace their roofs every 10-20 years, while others want modern kitchen appliances. Some structural flaws occur gradually, with mold being one of the many examples. During thunderstorms, floods, and other natural disasters, a home might suffer abrupt structural damage. Some of those structural damages may be apparent right away, but others grow beneath the surface and get discovered when they become unbearable.
Home equity lets you cover routine home improvements and urgent repairs even if you don’t have the necessary funds in your bank account. Time isn’t always on your side when you need to fix your home. Borrowing against home equity allows you to get immediate repairs and renovations instead of accumulating cash for several months before seeing any progress.
4. Consolidate Debt
Debt consolidation simplifies your financial obligations and can help you score a lower interest rate. Debt consolidation is the process of taking capital from one loan and dispersing it across smaller loans. Many borrowers use debt consolidation to eliminate their credit card debt since this balance has a double-digit interest rate. Home equity financing has a single-digit interest rate which makes it easier to repay. It’s common to find a fixed rate for your home equity financing which means the monthly payments are predictable. Other financing methods, such as credit cards, have high variable interest rates that add more variety to your monthly payments. You also don’t have to visit several platforms and remember payments for numerous small debts.
Forgetting about a small debt can hurt your credit score, and it can compound significantly over time if you get distracted by your other financial obligations. On the other hand, consolidating debt makes it easier to cover everything and possibly get a lower interest rate on the remaining balance.
5. Cover Medical Emergencies
You can’t plan a medical emergency. They happen by surprise, and some of them can get expensive. People get sick and need adequate resources and professional assistance to recover. Some medical expenses will exceed the amount of cash in your bank account, but most of these procedures can’t wait. Borrowing against your home equity gives you enough money to afford medical bills and provide yourself or a loved one with the proper care.
Medical bills take a toll on many people’s finances. Medical expenses contribute to more than 60% of bankruptcies. Tapping into home equity can save you from this fate and avoid delaying urgent care. Home equity gives you time to address medical emergencies right away, and flexible repayment terms can make the financial impact more manageable.
6. Pay for Education Expenses
Tuition continues to rise, and moving one or more children from high school to college can present quite the sticker shock for many families. Some families face tuition bills exceeding $40,000 per year for a single child. To shield their children from burdensome student debt, some families will tap into home equity instead of having their children take out loans. Home equity can make the expenses of higher education feel more manageable and keep your child out of debt. Parents who plan to send their children to college can financially prepare as high school graduation gets closer, but home equity can provide reassurance that college expenses will get covered.
Homeowners who purchased homes before raising their families usually have more equity to tap into when their children are ready for college. Those monthly mortgage payments add up, and your home’s value should grow over those years.
7. Invest
Investing allows your money to compound over time and is a popular path to wealth. However, you need money to get started. You can invest a percentage of your weekly paycheck, but this strategy may not lead to sufficient growth. Some homeowners use equity to speed up portfolio growth. Home equity can help you afford a down payment on a rental property, buy stocks, and purchase other assets. Investing your home equity proceeds is risky, but your wealth can rise substantially if you pick the right assets. Low interest rates make this strategy more enticing since you only have to outperform the interest rate to generate an ROI (return on investment). Your investments also have several years to compound, while fixed-rate payments stay the same over the life of the loan.
