There are benefits to homeownership.
One of the biggest benefits is equity. Equity is the part of your house that you own outright. Each time you make a mortgage payment, a part of the payment goes toward the principal of the loan. Because of this, each month you have more equity in your house, which is the difference between what your home is worth and what you owe.
The good news is you don’t have to sell your house or pay off your entire mortgage loan in order to take advantage of your equity. You may be able to borrow against your equity and use the money today. Here is how your equity can work for you.
How to borrow against your equity
There are two ways to borrow against your equity. You can take out a home equity loan, or you can open a Home Equity Line of Credit (HELOC).
A home equity loan is a one-time loan in which you have set monthly payments and a pay-off date. You might take out a home equity loan to pay for a new roof or to pay off higher-interest debt.
The amount you can borrow is based on how much equity you have in your home, as well as how much you can afford to pay back.
A HELOC, on the other hand, is a revolving line of credit. Rather than you taking out a specific loan, the line of credit is there for you when you need it. Think of it like a credit card. You have a line of credit that is available when you need it, such as if you have a large unexpected expense. It is then your responsibility to repay what you have borrowed over time.
How to get a home equity loan or HELOC
In order to be approved for a home equity loan or HELOC, you have to go through some of the same steps you would go through in other instances when you are borrowing money. The bank may ask you for the following:
- Proof of income
- Bank account statements
- Tax statements
An appraisal will also have to be done since the appraisal provides the best estimate of how much your house is worth and how much equity you have. The more equity you have, the more you could potentially borrow.
Finally, the bank will conduct a credit check and factor your credit score into their decision. The higher your score, the more likely you’ll be approved for a home equity loan or HELOC with low interest rates.
If your credit isn’t where you want it to be, there are steps you can take to improve your score before applying for a home equity loan or HELOC. You could:
- Pay all your bills on time.
- Try to pay down your debts.
- Check your credit report to make sure it is accurate. Mistakes on your credit report can bring down your score.
Why you may want to use equity
There are a number of reasons you may want to tap into your home equity.
- You may want to make home renovations
- You may need unexpected home improvements
- You may have an unexpected financial need
- You may lose your job
- You can be diagnosed with a chronic illness and face major medical bills
- Your child may be denied the college scholarship you were counting on
- Your pet may get sick and you may be faced with high veterinary bills
- You could get a divorce and have to start all over
Any of these events could leave you racking up credit card debt. However, using your equity to pay for some of these expenses may be a better choice.
Risks of taking out a home equity loan or HELOC
If you do decide to borrow against your equity, it’s important that you take it seriously. If you borrow money against your home and you fail to pay it back you run the risk of losing your house since your lender could foreclose on it. On top of that, you would likely damage your credit.
However, if you come up with a plan for paying back the money, a home equity loan or a HELOC can bring you substantial savings since interest rates are typically lower than those of personal loans and credit cards.
As a homeowner, you have financial power. Your equity is an asset. Make it work for you.