Are you in need of cash? Before you load up your credit cards and take out a personal loan, there may be a better loan facility available to you if you’re a homeowner. When you visit the bank for a loan, you have to consider fees, interest rates, and payment terms. In most cases, borrowing money from the bank or another lender comes with extortionately high costs.
Home Equity Loans Explained
Fortunately, there’s a way to borrow money against your house, provided that you have some equity available in your home loan. Home equity lines of credit allow you to borrow against the equity available in your home. So, what is home equity? If you purchased your home a few years ago, for a purchase price of $200,000, and since then you’ve managed to pay off roughly $50,000 – Then you have $50,000 of equity available in your property.
Likewise, if the average price of homes in your area has risen $50,000 in the years since purchasing your home, then this can add to your home equity as well.
Banks create credit line on your home based on the amount of equity available in the mortgage facility. Some banks will also allow you to extend your home loan to the new purchase price of the property. In our example above, if you have $50,000 of equity and the value of your home has risen $50,000, it’s possible to get a credit line for $100,000.
Not all lenders will allow you to take out the additional $50,000 attributed to the rise in your home’s market value. However, all of them will permit you to take out $50,000 based on what you’ve paid off into the mortgage.
The Difference Between Home Equity Loans & Home Equity lines of Credit
Home equity loans are different from home equity lines of credit. The primary differences between the two are that a home equity loan issues you at the fixed lump sum at a fixed interest rate and monthly repayments. A home equity line of credit provides you with a credit facility to line against whenever you wish. As a result, there is no fixed interest rate and no fixed monthly payment.
You only pay interest on what you draw from the credit line. For example, if you have $100,000 of equity in your home, the bank will issue a credit line for $100,000, but you do not have to draw the entire amount at once. If you only draw $10,000 from the credit line, then the bank only charges interest on the $10,000.00, not the $90,000 remaining in the facility.
Home Equity Lines of Credit Vs. Personal Loans
The chances are that the bank gave you a favorable interest rate when purchasing your home. The interest on mortgage facilities is far cheaper than personal loans. In some cases, personal loans can charge interest rates as higher 17 to 27-percent, depending on the lender.
Compare this to the average home loan facility, charging rates of 4-percent. It doesn’t take a genius to figure out that the cost of loaning money to buy a home is far less than taking out a personal loan.
Therefore, taking out a home equity credit line to loan money from the bank will save you thousands of dollars in interest payments. The bank attaches the credit line to your existing mortgage, using the property as collateral to secure the funding. This security minimizes risk in the transaction for the lender.
The facility gives the homeowner access to cheap money, which they can use on anything they please. Banks do not take an interest in what you intend to use the money for, with their only concern being that you meet your monthly mortgage obligations.
The Risk in Equity Loans
As mentioned, the bank attaches the credit line to your home as collateral and the deal. If you default on your payments, then the bank will repossess your house and sell it to cover the outstanding amount due.
The thought of losing their home may seem frightening to homeowners. However, should you default on any credit facility with any lender, then there is a risk of a foreclosure on your home.
Your property is typically the first asset liquidated when the lender tries to recover their funds. Therefore, the only threat in a home equity line of credit is the fact that you might not pay it back, and the bank may repossess your property.
The Best Ways to Use a Home Equity Line of Credit
How can a home equity line of credit benefit your current financial situation? Here are a few ideas of how you can put the equity to good use, and improve your finances.
Settle Expensive Debt
The average credit card APR in the United States is over 17-percent. In many cases, consumers are so strapped for cash in a tightening economy, that they can barely afford to make the minimum payments on the credit cards.
Many consumers have a constantly revolving line of credit with a bank, that’s costing a fortune. In some cases, consumers cannot afford to pay down the total balance of their credit cards. As a result, they only pay off the interest every month, while not paying down anything on the principal. This situation leaves the consumer in a perpetual state of debt that they find challenging to escape.
Taking out a mortgage line of credit allows you to pay off all your expensive debt, including credit cards and personal loans. These facilities charge four to five times the amount of interest than a mortgage. Some banks may offer home equity loans or lines of credit slightly above what you received for your mortgage rate.
At the moment, the average home equity credit line has an APR of 5.49-percent, which is still far less than the 17-percent or more, charged on credit card facilities.
Settling your credit card debt using a home equity line of credit, is a prudent strategy to help you recover your finances to a favorable position. However, once your credit cards are clean, it’s vital that you have the financial prudence to avoid loading up on debt again.
Credit cards are the most logical reason to consolidate your debt at a lower interest rate, using a second mortgage or equity line of credit. However, you can use your equity loan to settle other high-interest debt as well. If you have an auto loan, private student loan, or personal loan outstanding, these facilities charge a much higher interest rate than a home loan. You can consolidate all of this debt into your mortgage, and pay far less than you would with the original facilities.
The lower APR on home equity lines of credit can save you thousands of dollars over the long haul, allowing you to become debt-free sooner. It’s important to note that minimizing your debt using consolidation, is as good as saving.
Home Additions and Improvements
Have you been thinking about installing a swimming pool in your backyard? Maybe you’re considering upgrading the tiling and your home, or building an apartment above your garage for rental income?
Accessing a home equity line of credit can help you make the home improvements at an affordable cost. Remodeling your home adds value to the property while allowing you to enhance your living standards.
If you’re smart with your home improvements, then you could receive a significant increase in your property value. For instance, recent research shows that replacing your garage door retains 97.5-percent of its replacement value. The same study shows that remodeling your kitchen allows you to add 80.5-percent of the remodeling costs onto the value of your home.
As a bonus, if you qualify, the IRS will allow you to deduct the interest on your home equity line of credit from your taxes. The IRS allows for this deduction if you intend to buy, build, or substantially enhance the home that secures the loan.
Purchase a Second Property for Rental Income
Using a home equity line of credit is a great way to consolidate your debts and put you on the path to financial freedom. However, taking on debt can be far more productive if you use it as leverage to purchase income-producing assets.
You can use the equity available in your home to purchase a rental property that produces income. Placing a substantial down payment on a condominium or single-family home allows you to position yourself with positive cash flow from the start of the new mortgage.
This strategy means that you don’t have to contribute to a shortfall in the mortgage payments. In this scenario, an income-producing property gives you two assets in your portfolio, allowing you to use the rent to pay down the mortgage without having to contribute to a rental shortfall.
Using this strategy enables you to benefit from purchasing a second property, without using your income to pay the mortgage. After you pay down the investment property, you have an income-producing asset. The rental property provides you with money at the end of every month, without you needing to work for the income.
You can use this income to pay down your original mortgage or increase your standard of living.
Open a Business
Do you have to dream of starting your own business? If you have a sound business model, then you can use your home equity line of credit to start your company. Using this funding strategy circumvents the need to approach the bank or a financial institution for funding.
A home equity line of credit gives you access to a significant amount of cash upfront. You can use these funds to start a franchise, buy a cash business, or invest in a company. This strategy is another example of productive use of your home equity line of credit that produces income, rather than putting yourself into further debt.
Owning a business allows you to escape the daily grind of your job, replacing the earned income from your job, with passive income from your investments. Business loans typically have a high APR, and the extensive application process is not always successful. Many banks require thorough vetting of the company and your finances before they loan you money.
Using a home line of credit helps you overcome this financial hurdle, allowing you to fulfill your dreams of being a business owner.
Money for Emergencies
Now and then life throws a curveball at us that we did not expect. A home equity line of credit gives you the option of having cash readily available to you to use as you please. This credit can come in handy in situations like emergencies were you need money immediately.
Being retrenched at work can turn your life upside down. A home equity line of credit can help you pay the bills until you get back on your feet.
While most people have some form of health insurance, there are times where the healthcare provider may not cover the entire cost of the operation. This situation could leave you with expensive medical bills you cannot afford to repay. Having cash on hand could help save your life in an emergency.
Wrapping Up – When Not to Use a Home Equity Line of Credit
A home equity line of credit can be a blessing for anybody in need of cash quickly. The low-interest rates and favorable terms associated with the facility give you access to cheap money, at far lower rates than a personal loan. However, it may be tempting for some people to access a home equity line of credit to fund poor financial choices.
All of the reasons to use your home equity line of credit outlined in this article focus on either paying down your debt or increasing your cash flow through acquiring assets. This strategy is a prudent use of the facility; they can both increase your income while minimizing your liabilities.
However, if you intend on using your home equity line of credit for lifestyle purchases, this is a bad idea that could land you in financial trouble. Using your credit line to purchase new furniture or to go on vacation, is not a productive use of the facility. You might want to think twice about your decision before taking on more debt.
Going further into debt to fund your lifestyle, is a poor financial decision. Using your credit line for these types of purchases could end up costing you your home if you cannot pay back the money to the lender. Always discuss any financial decisions regarding a home equity loan with your accountant, to ensure that you’re making a prudent decision about how to use the facility.