Are you planning to buy another property but still don’t know how to finance the said purchase? Why not make use of your home equity? Yes, you heard it right. Using your home equity is among the best financing options that you have.
Unfortunately, not all homeowners know this. Due to their lack of appropriate knowledge, most have resorted to other loans to push their respective purchases through. Sadly, most of these loans have higher interest rates and inconvenient repayment schemes. As such, many homeowners have difficulty dealing with their loan obligations.
So, if you are looking for a convenient way to finance the purchase of a new property, consider using your home equity. But to obtain the desired results and avoid possible financial complications, you should research more about home equity. Also, it is equally helpful if you know the best practices that allow you to use home equity to your advantage. For a start, read some of the essential information about home equity provided below.
What is Home Equity?
Home equity refers to the home’s actual value minus all the liens attached to the said property. Technically, the amount of equity varies over time, and this is because of the homeowner’s mortgage payments and other factors that directly affect the current value of the property.
It is not only regarded as a mortgage loan that a homeowner has successfully paid off. Instead, it is considered an asset that the homeowner can borrow against to secure funds that can be used to finance various expenses, such as paying an expensive credit off.
How Does Home Equity Work?
Home equity is the part of a home’s current value that the homeowner owns. This means that when a house is purchased using a mortgage loan, the lender or lending institution owns most of the interest in the property. When the monthly payments are made, the amount paid is added to the equity, thereby increasing its value. Thus, the owner obtains home equity once the down payment is provided.
How is Home Equity Calculated?
Home equity can be conveniently calculated using simple mathematics. Since equity is the difference between the home’s actual and total value and the amount the owner owes to the lender, the equity can be obtained using the following formula.
- Value of Home – Loan Balance = Home Equity
If, for example, you purchased a home valued at $450,000 using a loan amounting to $250,000 and paid the remaining balance out of your savings. With the said figures, the equity can be obtained using the calculation below.
- $450,000 – $250,000 = Home Equity
- $200, 000 = Home Equity
How Do You Borrow Against Home Equity?
Unlike the other investments that you have on hand, home equity is something that you cannot easily convert into cash. This is because the equity calculation depends on your property’s latest value. However, home equity can be used as collateral to obtain several financing opportunities, which include the following:
1. Home Equity Loan
Home equity loans are an essential financial tool that can help homeowners make home improvements, pay off existing debts, or even fund big events like college or retirement. These loans are different from traditional home financing in the following ways.
- These loans are secured by the home itself, which means that the lender has a claim on the property in the case of default.
- These loans tend to have lower interest rates than unsecured personal loans or credit cards, making them a more affordable option for many borrowers.
- Most home equity lenders allow borrowers to borrow against up to 100% of their home value to access funds.
Overall, home equity loans offer a variety of benefits and play an essential role in helping homeowners to manage their finances and debt load.
2. Home Equity Line of Credit (HELOC)
A home equity line of credit, or HELOC, is a secured loan that allows homeowners to borrow against the equity in their property.
In most cases, homeowners need at least 20% equity in their home to qualify for a HELOC. Some key features of this type of loan include relatively low-interest rates and flexible repayment terms.
Also, HELOCs do not require any repayments or interest payments during an agreed-upon “draw” period, typically 5 to 10 years.
Although there are risks involved with taking out a home equity line of credit, it can be an effective way for homeowners to tap into some of the value of their property without having to sell it outright.
3. Fixed-rate HELOC
A fixed-rate home equity line of credit, or HELOC, is a home loan in which the borrower has access to a pool of funds that can be used for any purpose.
Unlike other home loans, a HELOC usually comes with a fixed interest rate that does not change over time. This makes it much easier for borrowers to plan and budget for their monthly payments, as they will know exactly how much they need to pay each month to keep up with their debt.
Other key features of a HELOC often include low opening fees, variable withdrawal amounts depending on property value, and the ability to deduct loan interest from taxable income.
4. Cash-out Refinance
A cash-out refinance of a home loan allows you to access the equity in your home in exchange for a new mortgage. This refinancing is typically used when you want to borrow a large sum of money and have sufficient home equity to qualify for a new mortgage.
Other benefits of a cash-out refinance include the fact that it can often offer much lower interest rates than other lending options and is tax deductible in some cases.
Additionally, by adding additional equity to your home through a cash-out refinance, you may be able to access home improvements or other financial investments that would not be accessible through traditional home loans.
Can You Purchase a House Using a Home Equity Loan?
A home equity loan can be used to purchase another property or house. This type of loan has been a common practice among many homeowners because the interest rate is more affordable, and the repayment options are flexible.
But despite the favorable conditions that buying a new house using home equity could provide, this doesn’t mean that getting a loan is the right thing to do. The practice has its own set of upsides and downsides that must be carefully looked into before pushing through with the purchase of a new home.
The Upsides
Buying another house using a home equity loan comes with many benefits. However, the most significant of these include the following.
- Getting a home equity loan allows you to obtain a lump sum payment that you can use directly to pay a down payment. As such, you’ll be regarded as a more competitive buyer. As such, you’ll have more opportunities to get lower interest rates and monthly payments.
- A home equity loan is a more convenient and affordable way to finance a second property. This is because getting other types of loans comes with stringent downpayment requirements.
- Getting a home equity loan allows you to enjoy the benefit of having lower interest rates, and this is because the loan is backed with collateral.
The Downsides
Getting a home equity loan to purchase a second property also comes with several downsides, including the following.
- Getting a home equity loan is technically swapping your asset for a debt. When you do this, you take the part of the home you own and incur additional debt.
- Getting a home equity loan exposes you to the sudden shifts in the housing market. And because you own two properties, you’ll most likely face more risk when something happens to the housing market.
- You’ll most likely lose both properties if you default on your loan.
- Getting a home equity loan could leave you with three mortgages and only two homes.
- Due to the changes in the tax codes in 2018, the interest payments for your home equity loan will most likely not be tax-deductible.
The Takeaway
Buying a new house using home equity can offer many benefits. However, doing this also comes with a number of risks that could get you into a difficult situation in case you fail to manage the two properties well. As such, you should assess your financial situation before taking out a loan for your next purchase.
