Homeownership can come with its fair share of challenges—particularly in the winter months for those in the Northeast and Midwest. But don’t let the frigid air and higher utility payments skew your view of the valuable impact owning a home can have on your financial well being and ability to make important investments. As home values continue to trend higher and higher, the same may be happening to the equity in your home. Have a big financial goal in mind for 2016? With a little homework, you might find that this is the year your home went to work for you.
Home equity, found in both a primary residence and an investment property, can be a valuable asset to leverage, but navigating the process to tap into your home’s equity can be confusing, particularly to new homeowners. With the rate of homeownership increasing among first time homebuyers (millennials between the ages of 25 and 34 make up 68 percent of this group according to National Association of Realtors data), I thought it would be helpful to review the home equity lending process.
Your Home as an Investment
Your home is a financial asset. A primary residence made up 62 percent of total assets for the median American homeowner households, according to the National Association of Home Builders in 2014.
To better understand the value of your home, it’s important to consider how you acquired it. If you paid cash on a $230,000 home, that home became an immediate asset on your household balance sheet. Assuming, however, that you are a more typical homebuyer and opted to finance your purchase through a mortgage, your home equity and assets increase each time you make your monthly principal and interest mortgage payment, with the liability that is your mortgage decreasing. The value of this equity is then determined by the current market value of your house minus the residual mortgage payments you owe.
Options for Using Your Home’s Equity
Two major lending products that allow you to take advantage of home equity are the home equity loan and the home equity line of credit (commonly known as a HELOC). The differences between these products can be hard to discern initially. They both rely on a valuation of your house as collateral to secure credit with your lender.
Where home equity loans differ from HELOCs, however, is in the interest rate and distribution of the loan funds to the borrower. While a home equity loan is paid out in a lump sum normally with a fixed interest rate, a HELOC sets up what’s called a revolving line of credit. Under a HELOC, the credit the lender provides often has an adjustable interest rate.
Home equity loans tend to be best suited to one-time events where you need access to a set amount of capital to cover a large expense. Examples of possible uses for home equity loans include major purchases, home improvements or even an unanticipated medical bill. Meanwhile, HELOCs tend to be a better fit for recurring costs, such as college tuition or paying down high interest debt.
It’s important to understand that there is no one-size-fits-all approach to determining whether or not tapping into your home’s equity is the right financial strategy for your family. As such, it’s important to consult with a lending professional or personal financial advisor to evaluate the benefits and risks.