For many homeowners, home equity — the part of their home that they’ve paid off — is their most valuable asset. In technical terms, home equity is the appraised value of a home minus the amount owed on the mortgage.
Your home equity grows with every monthly mortgage payment that you make. It also rises when the value of your home increases, such as when market values go up and when you make home improvements. Home equity is important not only because it represents your increasing stake in your home but because it’s an asset that you can use to raise cash.
Common Uses of Home Equity
Many homeowners never tap into their home equity, letting it build until they pay off their mortgage. But if you’re considering taking advantage of your home equity, let’s take a look at five of the most common uses:
- Home improvements. One of the most popular uses of home equity is making necessary or high-value renovations. Some home improvements, such as adding insulation or solar panels, can save you money over time. Others, particularly kitchen and bathroom upgrades, can immediately increase the value and enjoyment of your home.
- Emergency expenses. You may already have an emergency fund, but life is full of surprises. If you face a financial emergency — due to job loss, healthcare bills, or other unforeseen circumstances — using your home’s equity as a lower-interest alternative to credit card debt or loans may be an option to consider.
- Debt repayment. Paying off high-interest debts, such as credit card balances or auto loans, is another common way to use home equity. By consolidating your debts into a lower-interest loan secured by your home, you can reduce your monthly payments and minimize the number of debts and creditors you have to deal with.
- College expenses. Although student loans are the most common way to pay for college, some people use their home’s equity to pay tuition and other college costs. It can be a money-saving approach when mortgage rates are much lower than student loan interest rates.
- Wedding, vacation, or other personal expenses. For some homeowners, it may make sense to use their home equity for large personal expenses, such as a wedding, a vacation, or another special life event. Personal loans usually have much higher interest rates than loans that use your home as collateral. Many financial advisors, however, counsel avoiding using home equity for these types of expenses. It’s often better to lower your budget or find other ways to pay for these types of events.
Get Expert Advice
If you’re thinking about using your home equity, there are three basic ways of tapping into it:
- Refinancing your mortgage. When mortgage rates drop sufficiently below the rate you’re paying on your current mortgage, it can be advantageous to arrange a new mortgage at the lower rate. You use the money from a cash-out refinance to pay off your old mortgage and use the leftover funds for other purposes. A cash-out refinance may also lower your monthly payments.
- Taking out a home equity loan. Also known as a second mortgage, a home equity loan is a loan that uses your home as collateral for the loan. Like many mortgages, a home equity loan usually has a set term, a fixed interest rate, and steady monthly payments.
- Setting up a home equity line of credit. A HELOC is similar to a credit card. You can withdraw funds — up to your credit limit — and pay back the funds over time. Most HELOCs have a variable interest rate.
Each of these methods has distinct advantages and disadvantages. If you need to raise cash, research all of your options — including those beyond the ones involving home equity — and consult with your financial advisor. If you’re interested in exploring the possibilities of using your home equity, contact one of our loan specialists to discuss your options.