How to Use Home EquityIf you’ve been paying your mortgage for a while, you’ve probably built up some equity in your home. Maybe you’ve heard of a home equity line of credit or home equity loan, but you might not understand why it would be an option for you. Here’s an intro to home equity and how you can use it to finance your life events.
What is Equity in a House?The definition of home equity is the difference between how much your home is currently worth (or its market value) and how much you still owe on your mortgage. Here’s a quick example to help you figure out how much equity you have:
- Your Current Home Value: $150,000
- Minus Your Current Mortgage Balance: $100,000
- Equals Your Home Equity: $50,000
Mortgage lenders let you borrow against your home’s equity, using your home as collateral, which is why they are sometimes referred to as second mortgages. The general guideline is that you can borrow up to about 75-80% of your home’s value, minus what you still owe on your house. The equity that you’ve built up in your home can be leveraged for a variety of purposes, including:
How You Can Use Home Equity
- Home improvements
- Debt consolidation
- Education and College
- Major life events
- Vehicle purchase
What Are the Benefits of Using Your Home Equity to Finance?
Home equity loans usually have a lower interest rate and can give you a large sum of money. There are two different ways you can access your home’s equity, either as a home equity line of credit or a home equity loan.
How Does a Home Equity Line of Credit Work?
With a home equity line of credit, or HELOC, you can take out money as you need it during the draw period. A draw period is the amount of time you can withdraw funds from your home equity line of credit and is determined by the lender. This is similar to a credit card, in that once you pay off what you’ve borrowed, you can borrow more. For example, if you write a check for $6,000 from your $10,000 home equity line of credit, you can still borrow an additional $4,000. Plus, when you pay back the $6,000 or a portion of it, you can access the money again. With HELOCs, the interest rates can be variable or fixed. Your payments are based on how much credit you’ve used, as well as the current interest rate.
What is a Home Equity Loan?
A home equity loan allows you to take out a lump sum of money, similar to a personal loan. Like a home equity line of credit, your home equity loan will be determined based on the value of your home and your mortgage balance. With a home equity loan, your interest rate is typically fixed, and your repayment amount is the same each month. In contrast to a HELOC, you can’t keep taking out money once you’ve paid back the principal.
How to qualify for a home equity loan or home equity line of credit.
To qualify for a home equity loan, lenders will look at your debt-to-income ratio, or DTI, to figure out how much of your income is already promised to other lenders. This factor helps lenders determine if you’re a good fit for this type of loan. Typically, the lower your DTI, the greater chance you have to qualify for a home equity loan or line of credit. Lenders look for your DTI to be under 40%. If you aren’t there yet, try to pay down your debt or reduce your other monthly expenses.
Mortgage lenders will consider your loan-to-value ratio, or LTV, too. This is the amount you still owe on your mortgage divided by your home’s current market value. To make sure your home’s value is accurate, you’ll need an appraisal. Typically, the lower the ratio, the better your chances of qualifying. Generally, LTV ratios need to be 80% or below to qualify for a home equity line of credit.