Accessing home equity for remodeling, debt consolidation, or meeting unexpected expenses can be a good choice or a not-so-good one. Use these tips to determine if a home equity loan or line of credit can improve or sabotage your financial well-being.
- Estimating home equity: Home values have changed in many areas. Contact a real estate professional familiar with your neighborhood or use an online valuation site to see if values have increased or dropped. Your home equity equals the home's value minus the total mortgage loans against it.
- Understand how much you can borrow: Mortgage lenders require more equity than they used to for a refinance. If you have less than 20% home equity, you'll have a hard time refinancing unless you choose a government mortgage like FHA or the HARP program.
- Changes in home value impact your home equity: Borrowing against home equity reduces your protection against falling home values and can cause your home to be underwater, which could be a problem if you need to sell or move.
- Refinance or home equity financing: Refinancing fees are often based on the loan amount. Taking out a home equity loan or line of credit is another way to get cash from your home and the fees are much lower.
- Home equity loan or line of credit (HELOC): Both of these options reduce your home equity; a home equity loan is also called a second mortgage. You get a lump sum at closing and pay it off with equal payments over time. A HELOC is a credit line drawn against home equity. You use the credit line as needed and pay interest only on the amount used. Home equity lines of credit usually carry adjustable interest rates. Choose your option according to your financial needs. If you're consolidating multiple debts on a one-time basis a home equity loan may be your best option. If you are remodeling your home and will be paying multiple vendors over time, a home equity line of credit allows you to meet expenses as they occur while providing funds for additional expenses.
- Foreclosure risk: Home equity loans and lines of credit are secured by your home and lenders can foreclose for non-payment. A home equity lender can also foreclose if you default on your first mortgage, as foreclosure of a first mortgage eliminates home equity loans.
Discuss your financial goals and needs with an objective financial advisor to determine your best options for home equity financing or other alternatives.