Building your equity over time as you pay back your mortgage can give you a feeling of success and excitement about the nearing prospect of owning your home outright. It also gives you the ability to access funds through a home equity line of credit or a home equity loan.
There are many reasons why people may be tempted to use their equity, and it can be a great way to save money by scoring a lower interest rate than you could get with a credit card or another type of loan. It is important to carefully consider the financial impact of that choice, however, and whatever the reason is, there are certain guidelines you should keep in mind.
ï¿½You normally donï¿½t want to borrow more than 80 percent of your homeï¿½s current value, a ratio that includes your first mortgage,ï¿½ states NerdWallet columnist and author of the best-selling book ï¿½Your Credit Scoreï¿½ Liz Weston. ï¿½Youï¿½ll typically get better rates and terms, plus youï¿½ll be left with a cushion for emergencies.ï¿½
One of the most common reasons that people use equity is to tackle a project that can add value to their home. Not all projects do add value, however, so review your intended project carefully and consider talking to your financial institution and a local real estate agent to determine exactly how much return on the dollar you can expect.
You may be able to get more return on investment if you are selling your house soon. Not only will the improvements still be in peak condition, they will reflect the latest trends. So, if you are considering moving in the next couple of years, it could be the ideal time to tap into equity. Even if you arenï¿½t planning on selling, if your home has increased in value, it can also make sense to use equity on improvements.
ï¿½You can leverage that equity at a low rate to improve your home and make it more comfortable,ï¿½ stated Justin Lopatin, vice president of Mortgage Lending for PERL Mortgage in Chicago, in an article for Bankrate.com. ï¿½If you can tap into equity without increasing overhead to the point that itï¿½s not affordable or comfortable for you, thatï¿½s a good reason.ï¿½
Using equity can also serve you well if an emergency expense arises. Although everyone knows the benefits of having an emergency fund, it can be a difficult task for many people to create one, depending upon their financial situation and other factors like a new baby or career change. This is especially true considering the fact that financial planners generally recommend the lofty goal of saving at least three months of expenses, according to Weston.
ï¿½Unfortunately, it can take a typical family two years to save up that much, and a lot can go wrong in the meantime,ï¿½ she states. ï¿½A HELOC can supplement an inadequate emergency fund and be a comforting Plan B while you build or rebuild your cash stash.ï¿½
Last, funding a new business with your home equity can help you score a lower rate than you would get on a business loan.
ï¿½Itï¿½s hard to find a loan at better rates ï¿½ less than 4 percent for borrowers with good credit ï¿½ and qualifying for a home equity line of credit is easier than it is for a business or personal loan,ï¿½ states U.S. News & World Report contributor Teresa Mears.
So, if you have a business opportunity that requires you to move quickly, the expediency of the HELOC process could be just what you need.
Knowing you have equity to fall back on if you have a large emergency expense, need to finance a business or want to improve your home can provide great peace of mind, as can talking to your financial institution about the best way to manage and use your home equity.