It’s been six months since we put our house on the market; six months of keeping our home spotless in case of last-minute showings, which have all resulted in not a single offer. As we kept dropping the price tag on our home – it’s now far below its appraised value – my husband and I kept asking ourselves, “This property is worth so much more; surely, there’s something better we could do with it?”
And there is.
Tapping Your Home’s Equity
The answer to our problems could come from tapping into our home’s equity. Currently, we have nearly $40,000 worth of equity in our property – not bad considering we bought it at the height of the real estate boom and (naively) put down just five percent. Instead of losing just about all of that by selling it for well under market value, we’re considering using the equity in a different way.
Using your home’s equity usually happens in one of two ways: by taking out a home equity loan or a home equity line of credit, sometimes called a HELOC for short. While they sound very similar, there are some stark differences. A home equity loan functions like a second mortgage, using your home’s equity as the collateral; the loan is a fixed-rate for a set number of years, which you pay back in month installments. A HELOC, on the other hand, operates more like a credit card; the interest rate fluctuates, and you can “charge” up to the line of credit’s limit, typically the amount of equity you’re borrowing against. Just like a credit card, you can either make payments in full, or just pay the minimum and incur the interest.
In both cases, determining the amount you can borrow is essentially the same. In a slow housing market like we’re currently seeing, multiply your home’s appraised value by 90 percent, then subtract the remaining principal balance on your home loan – that’s typically the maximum amount lenders will let you borrow on a home equity product; in my case, that would be about $24,000.
House rich but cash poor? Tapping your home’s equity can change that. If you have enough equity in your home – lenders typically like to see 20 percent or more – you can pull out that money with a home equity product to use at your discretion. For example, maybe you’re about to embark on a huge home improvement project, or need to pay off other high-interest debts; a home equity loan can give you the cash you need in a one-time lump sum. Or perhaps you need access to the equity in your property to pay your kids’ college tuition or cover expenses during a period of unemployment – a HELOC is ideal for that.
There are also tax breaks, just as there are for first mortgages. In most cases, property owners can write off interest on loans under $100,000, even if you’re using the money to buy something frivolous like a sports car.
The main risk that comes with using a home equity product is that you’re taking out a loan and using your equity in your property as collateral – leaving you with little or no equity at all. In other words, if you can’t make the payments on your loan or line of credit, the lender has something very tangible to take from you: your home.
At the same time, you’re also subject to the ebbs and flows of the market itself. Interest rates go up? So will your interest charges on your HELOC. Property values go down? You may find your property underwater (owing more on it than the home is worth).
How We Could Use Our Home’s Equity
We’ve been toying with a home loan calculator to see just how pulling out some of our current home’s equity could help us get into a new home. The mortgage calculator showed us that with today’s low interest rates and housing prices, a 20 percent down payment would cost us around $50,000. By tapping the equity on our current home, using it to put a down payment on another, and renting out the existing house, we could buy our dream home and become landlords without breaking the bank.
Written By Betsy Falwell