Your home can be more than a place to live. As you pay down your mortgage and your property's value changes, you may build equity that can potentially be used for renovations, major expenses, debt consolidation, or other financial goals.
Before borrowing against that equity, it is important to understand how home equity works, the financing options available, and the risks involved.
What Is Home Equity?
Home equity is generally the difference between your home's current market value and the amount you owe on loans secured by the property. For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, you would have approximately $200,000 in equity.
That does not necessarily mean you can borrow the entire $200,000. How much equity you can access depends on factors such as the loan program, lender requirements, property value, existing mortgage balance, credit, income, debts, and your ability to repay.
How Do You Build Home Equity?
Equity can grow in several ways. As the principal balance of your mortgage decreases, your ownership stake generally increases. Your equity may also increase if your property's market value rises.
Home improvements can sometimes add value as well, although homeowners should not assume that every renovation will produce a dollar-for-dollar increase in property value. Home values can also decline, which can reduce available equity.
What Are the Main Ways to Access Home Equity?
Homeowners generally have several borrowing options to consider:
- Home equity loan: Provides a lump sum using your home equity as collateral. These loans commonly have a fixed interest rate and regular monthly payments.
- Home equity line of credit (HELOC): Provides a revolving line of credit secured by your home. You can generally borrow as needed during the draw period, up to the available credit limit. HELOCs usually have variable interest rates, so payments can change.
- Cash-out refinance: Replaces your existing mortgage with a new, larger mortgage and provides the difference in cash, subject to qualification and available equity.
If you already have a first mortgage, a home equity loan or HELOC generally creates an additional loan secured by the property. A cash-out refinance, by comparison, replaces the existing first mortgage.
How Should You Choose Between a HELOC and Home Equity Loan?
The intended use of the money can help determine which option is worth considering. A home equity loan may make sense when you need a defined amount for a specific expense and prefer predictable payments. A HELOC can provide more flexibility when expenses occur over time, such as during a renovation project.
With a HELOC, pay close attention to the draw period, repayment period, interest rate structure, fees, minimum payments, and how much the payment could change. Payments can increase when a HELOC enters its repayment period.
Consider the Risks Before Borrowing Against Your Home
A home equity loan or HELOC is secured by your home. If you cannot make the required payments, foreclosure is possible. Borrowing also reduces the equity you have available for future needs and could make selling or refinancing more difficult if property values decline.
Before borrowing, compare the interest rate, APR when applicable, closing costs, fees, monthly payment, repayment period, and total cost. Make sure the additional payment comfortably fits your budget.
Is Home Equity Loan Interest Tax Deductible?
Do not assume that interest is deductible simply because a loan is secured by your home. Under current federal tax guidance, interest on a home equity loan or HELOC may qualify as home mortgage interest when the borrowed funds are used to buy, build, or substantially improve the qualified home securing the loan and other requirements are satisfied.
Tax rules depend on individual circumstances and can change, so consult a qualified tax professional before making a borrowing decision based on a potential deduction.
Make a Plan Before Using Your Home Equity
Home equity can provide access to financing, but it should be used carefully. Start with a clear purpose for the money, compare available borrowing options, and understand how the new obligation will affect your monthly budget and long-term financial plans.
Loan Wolf Lending can help Florida homeowners compare HELOCs, home equity loans, cash-out refinancing, and other mortgage options based on their individual circumstances. Call 754-755-3075 to discuss ways you may be able to access your home equity.