Earlier in the year, we wrote a brief article about how to use home equity (you can read it here). Today, we want to dive a little deeper.
Many people turn to credit or loans to supplement their funds when necessary. Whether it’s a big purchase like a car or your child’s school tuition, or simply funding your next renovation project, learning how to use your home equity could be a great way to fulfill your needs with less interest than more traditional methods.
We definitely understand that using your equity may sound a bit scary, which is why our team at Cornerstone Bank focuses on easing our customers’ financial concerns. Based on our years of experience, we’ve created a guide to help you maneuver through the world of home equity.
Keep reading for all you need to know about the different ways you can use home equity for your large expenses.
What is home equity and how does it work?
If you’re a homeowner, you probably have some awareness of home equity. Yet for many people, the idea can still be a little confusing. So let’s break it down in simple terms.
Home equity is the difference between how much you owe on your mortgage and how much your home is worth. For example, if you owe $50,000 on your mortgage but your house is worth $100,000, that’s a lofty $50,000 in equity you’d have (keep in mind this won’t be how much you can borrow).
You can also build equity the moment you buy a home based on your down payment. The larger your down payment, the more equity you have at the start. If you put $20,000 down on a home that sold for $100,000, you would only need a $80,000 mortgage. That means as a new buyer, you will have $20,000 worth in equity.
How do I know my current equity?
To get the most accurate number, you’ll want to talk to a real estate appraiser. However, you can get an idea of what your home equity might be based on comparable home sales in your neighborhood. For those serious about using their home equity for other purposes, do not base your plan on comparable sales numbers. You can use it as a starting point, but an appraiser will be your next (and necessary) step.
As time passes, you can increase your home equity in two main ways:
- Paying off your mortgage
- Increasing the value of your home
Keep in mind that equity doesn’t always increase. If the value of your home drops or you fail to pay your mortgage on time, that could negatively impact your equity growth.
Ways to build equity on your home
While equity can drop, don’t let that deter you! Oftentimes, the longer you stay in your home, the more value you gain out of it (of course, you’ll want to take care of it). Here are a few tips you can use to help you build equity throughout the years.
Put down a larger down payment
Try to put down as much money as possible when you buy a home. As we stated before, the more money you put down, the less you’ll require for your mortgage. That means you’ll end up with more equity early on. For some people, doing so requires them to wait on a home for a little while longer to save up, but the wait comes with a lot of benefits in the long run.
Pay your mortgage on time
On-time payments are key to avoiding foreclosure and fees. Part of your mortgage payment will go toward the principal balance of your mortgage, while other parts are reserved for things like interest, property taxes, and homeowner’s insurance. When you first buy a home, less money goes toward your principal balance. Don’t let that discourage you, though! The longer you have a mortgage, the more money will go toward the balance. If you keep paying on time (preferably more than the minimum requirement), you’ll start noticing a big difference.
Renovate when possible
A great way to add value to your home is through renovations. You don’t have to do a huge project like remodeling the kitchen or master bathroom. Even painting your home or adding more landscaping can boost your curb appeal. This is especially helpful if you already live in a nice neighborhood with homes that are well taken care of.
Here are a few other project ideas that could increase your home’s value, and therefore your equity:
- Adding fencing to the front and/or backyard
- Purchasing and installing new appliances
- Replacing the floors in one or more parts of the house
- Replacing the HVAC system
- Updating the roof
- Enhancing your home with “smart” technology
- Hire a home inspector for regular inspections
How to use home equity to buy a home
As much as you may love (or may not love in some cases) your current home, there comes a time when you might have to say so long. Growing families, moving jobs, or even simply the desire for something new can lead you to put your current home on the market.
So say you’ve built $60,000 in equity from selling your house, meaning you received $60,000 more for your home than you bought it for. Now, due to fees and other expenses, you probably won’t receive the full $60,000, but you will still have a lofty profit to put toward a new home.
In some cases, people gain so much equity on their old home that they can buy a bigger home with a smaller mortgage. That’s all due to the amount of money they can put down, which leads them to borrow less money on their new mortgage.
How to use home equity to borrow money
If you want to use your home equity for reasons outside of buying a new home, you will need to visit a bank to borrow money. The great part about this option is that the interest rates tend to be lower than credit cards or other loan options. That is why many people choose to use their home equity to pay for large projects, their child’s college tuition, and even taxes. Make sure you consult a tax advisor before you make any decision.
There are three main ways you can borrow money via equity (in order):
- Home equity loans (i.e. second mortgage)
- Home equity line of credit (HELOC)
- Cash out refinance
Home equity loans
Home equity loans, often referred to as a “second mortgage,” allows you to obtain most of your equity in a single lump sum. Once you get the money, you can use it for whatever you want. Some people choose to use home equity loans to pay for their child’s tuition since the interest rates are often much lower than parent loans and can compensate for when you don’t receive enough federal aid.
Much like your mortgage, you pay off your equity loan on a monthly basis with interest, and it comes with a set term. Keep in mind that this “second mortgage” may come with a higher interest rate than your initial mortgage.
Home equity line of credit (HELOC)
If you don’t require a lump sum amount, a home equity line of credit might be your best option. A HELOC works similar to a credit card. You can spend money in increments with the limit being based on your equity (typically up to 85%). For some people, this is the cheapest option, because you only have to pay back what you spend.
Cash out refinance
With a cash out refinance, you can refinance your home for more than you currently owe on your mortgage. This allows you to use the difference in funds for whatever you may need. Then you would repay your “new” mortgage via monthly payments.
To break it down, a cash out refinance works like this. If you currently owe $50,000 on your mortgage, you could refinance for $80,000 and use the additional $30,000 for your financial needs. As a result, you would owe $80,000 on your mortgage that you will continue to pay off with monthly payments.
How to know which equity borrow method works best for you
The best way to understand which borrowing option will work best for you is to talk with a professional. If you’re in the Kansas City area, our bankers at Cornerstone Bank can always help you discuss your options.
Before you do anything, you will want to know how much equity you have on your home, along with your credit. As with any loan process, credit will always come into play and will determine how much money you can borrow.
Although situations vary from person to person, here are some factors that play into which type of method people choose.
Monthly payments: Some people would rather not have more than one bill for their mortgage, which is a reason to choose the cash out refinance option.
Amount needed: If you don’t know exactly how much money you need (i.e. you’re starting a business), a home line of credit may work best. But if you know the exact amount such as taxes owed or a college tuition, a home equity loan could work just fine.
Ability to pay off: The most important thing is that you can pay off however much you borrow. That might mean you start small and build your way up if needed.
Our bankers at Cornerstone Bank are here to help.
Since 2001, Cornerstone Bank has put our customers first, and that means giving them the best banking has to offer. We don’t believe in simple banking; rather, we go above and beyond to help our customers make their money work for them.
For more information about how to use your home equity, visit our Overland Park office or give us a call at 913-239-8100 to let us know how we can help.