Your home’s equity can be a powerful tool. Here are some ways to leverage it.
While home prices are high, you may have more equity in your home than you think. And using the equity in your home can be a powerful financial tool if used correctly. Let’s look at two common ways to tap into the equity in your home:
- Home Equity Line of Credit (HELOC). With this type of loan, you borrow against the available equity in your home, using your house as collateral for a line of credit. As you repay your outstanding balance, the amount of available credit is replenished (much like a credit card). Use the funds as you need them and only pay interest on the portion of the credit line you use. There are typically no closing costs and a quicker approval process when you open a HELOC.
- Cash-Out Refinance. You can refinance your mortgage for a higher amount (based on your home’s equity) and take out the difference in cash. Even though you don’t necessarily take on an additional loan with a cash-out refinance, you’ll still increase your overall debt load (with your home as collateral) and pay closing costs. It may make sense for you, though, if you have a better credit score than when you originally got your mortgage because you’ll likely get better terms on your new loan.
Smart Ways to Use Your Equity
In both instances mentioned above, you can use the equity in your home to finance other expenses. Here are some ways to put your equity to good use:
- Make home improvements. Just be sure any improvement you make using the equity in your home adds value to it. Common examples include remodeling your kitchen, installing solar panels, adding energy-efficient windows, or upgrading the exterior siding on your home. And when you make home improvements, choose the options that are best suited for your home — you wouldn’t put a $50,000 gourmet kitchen in a $200,000 home (especially if you plan to sell your home at some point in the future).
- Invest in a business or property. If you plan to start your own business, or you’d like to invest in a property or other business venture, using your home’s equity may be an excellent way to do so. Use care in how much you invest because of the risk involved — your home is the collateral. Typically, you should invest no more than 80% of your home value for this purpose.
- Cover emergency expenses. Life can be challenging. But using your equity, you can access an “emergency fund” available for any costly or unexpected situation, such as more substantial medical expenses or major car repairs.
It’s essential to look at your home’s equity as a way to invest in your future — not as a petty cash fund for things you want now (but really can’t afford). Typically, if you use a HELOC or cash-out refinance loan, you’ll get a lower rate than using other loans because you’re putting your home up as collateral. And because your home is the collateral for the loan, it may be at risk should something go wrong with your loan. But when you use your home’s equity in a way that gives you a positive return for your future, you’ll maximize your investment and potentially save money as well.
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*Consult your tax advisor.