Understanding Home Equity

Posted by Steph Kaye on Tuesday, May 6th, 2014 at 5:23pm.

Do You Really Understand?

If you are in the market for credit, a home equity plan is one of several options that might be right for you. Before making a decision, however, you should carefully consider the costs of a home equity line against the benefits. Shop for the credit terms that best meet your borrowing needs without putting yourself in undue financial risks. And remember, not being able to repay the amounts you’ve borrowed, plus interest, could mean the loss of your home. 

A home equity line of credit is a form of revolving credit in which your home serves as collateral. Because a home often is a consumer’s most valuable asset, many homeowners use home equity credit lines only for major items, such as education, home improvements, or medical bills, and choose not to use them for day-to-day expenses.

With a home equity line, you will be approved for a specific amount of credit. Many lenders set the credit limit on a home equity line by taking a percentage (say, 75%) of the home’s appraised value and subtracting from that the balance owed on the existing mortgage. For example:

 

Appraised value of home                       $100,000 

Percentage                                                  x75%

Percentage of appraised value               = $75,000

Less balance owed on mortgage             -$40,000

________________________________________________________

Potential line of credit                               $35,000


Some scenerios might help you understand the best options if you were in need of money.

1. Let's say your neighbors just sold their home for a pretty decent amount. That has to mean your house is worth at least as much as theirs. Even though your kitchen hasn't been redone like theirs, but your exterior is prettier, so that's probably a wash. Right? 

Well, not exactly...your neighbor's home sale might give you an idea of what your home is worth, but there's a lot more to it. Your home's age and its condition, the square footage, the location on the street—all of this factors in to determining your sales price.  You also have to take into account your credit and payment history. Straight equity is only one part of a more complicated equation. 

2. You've been living in your house and paying the mortgage for 15 years without refinancing. Your house has to be worth a fortune... time for a cash-out refinance. First you'll pay off your credit card bills, buy a few extra things, then live your life almost debt free. 

But, be careful cash-out refinance will allow you to "refinance your mortgage for more than you currently owe, then pocket the difference," said Bankrate, can be a great option, depending on your financial condition and what you plan to do with the money. "Remember the Mother Goose rhyme about the old woman who lived in a shoe? That is so 18th century. Today, she would live in a piggy bank, and so would her neighbors. Homeowners today treat their houses like piggy banks, readily transforming their equity into cash and credit."

Different from a home equity loan, a cash-out refinance replaces your existing first mortgage. You may have lower rates than with a home equity loan but you pay closing costs, just like you would on any refinance, and you'll have to pay private mortgage insurance "if you end up borrowing more than 80% of your home's value." If your interest rate is much higher than going rates and you know you have a good amount of equity, it might make sense to do it. But if you have terrible credit, your rate might not get much better. And, you'll have to decide whether refinancing and going back to square one with a mortgage is worth it.

"If you're going to make payments for 15 or 30 years, it makes sense to spend the money on something lasting, like an addition to the house that will increase its value, potentially lifesaving experimental medical treatment that your health insurance won't pay for or to start a business," said Bankrate. "Do you want to spend 15 years paying for your month-long dream vacation? Do you want to spend 30 years paying for items that you don't even remember buying, but are still paying for? 

3. It's hot outside. And it's hot in the real estate market and you want to take advantage of both and decide to build a pool. So, you'll just get a home equity loan or a line of credit. What's another couple bucks a month?

 But, you should know a home equity loan is a separate loan on top of your first mortgage that's paid out in a lump-sum and is paid back in fixed monthly installments. An equity line of credit is a specific amount you can borrow against your home. Both will require you to have sufficient equity in the home, which will be determined by the bank.

The home equity loan is a fixed rate, while a home equity line of credit "typically fluctuates with the prime rate," said US News. "Remember that with a home equity loan, you are paying interest on the entire amount of the loan, whether or not you are using the proceeds. With a home equity line of credit, you only pay interest on the amount you borrow."

The loan usually has higher rates than a cash-out refinance, but interest is a tax write off and may be a good option for someone whose "current mortgage is at a lower interest rate than you could get now by refinancing," said Bankrate. And if the money loaned is being used to improve the home and not improve your wardrobe, or other unnecessary items all the better. "The best use for home equity is to buy things that will contribute to your home's value, like a needed remodel, or your family's future income, like a college education,"said Houselogic. "Consider carefully before you cash in home equity to spend on consumer goods like clothing, furniture, or vacations.

  • Use a home equity line of credit for improving your home or buying other properties or land. These are long-term appreciating assets and will help you preserve your wealth.

  •  Avoid worsening your financial situation by poor use of the home equity line of credit. Don't squander your equity on consumer goods, vacations and daily living expenses, as paying it back will be difficult.

  If you are in the market for a new house and would like information on homes for sale, or are first time home buyer not working with a Realtor and would like to schedule a consultation with a qualified Oakland County and Macomb County Realtor, please complete the Lang Premier Properties contact form to have a real estate agent contact you. 

  Lang Premier Properties are Birmingham Realtors specializing in Oakland County Real Estate. Stephanie is an agent with Max Broock in Birmingham, Michigan. See what past clients have to say about Stephanie Lang.  Lang Premier Properties looks out for your best interests when you purchase a new custom luxury home. We always recommend working with an experienced luxury real estate agent when buying a new luxury estate.

 




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