So if you own a home, you may have heard of or used something called a HELOC, otherwise known as a home equity line of credit or a home equity loan.
These are loans against the equity you have in your home. So let\’s say you purchased your home for $215k in 2011, and in 2021 that home is now worth $345k. Equity is the difference between what the home is worth and the note or notes you have against the property. So let\’s say you still owe $171,471.21 based on the amortization schedule of paying $1,083.00 monthly for principal and interest for ten years. So your equity would be the difference of what the home appraises for based on current comparable sales. In this case, the $345k market value would be minus your current balance of $171,471.21, equalling $173,528.79. Now that\’s a nice sum of equity, and most believe that you should have access to all of it, but that\’s not often the case.
Usually, banks and institutions will finance up to 80% of the market value.
So this means that the value would be set at $276,000.00 minus what you currently owe at $171,471.21, equalling $104,528.79 of equity that a loan can then be made for.
Of course, each bank or financial institution will have different limitations, and you will want to shop around to find the best fit for your needs.
Assuming you utilize all $104k, you can set it up as a home equity line of credit or a home equity loan. A home equity line of credit will allow you to use whatever portion of the $104k you would like, and your payment will then be made based on your utilization. These loans typically have to be renewed and reevaluated annually and come with a variable rate based on market conditions. Ideally, you will have a home equity line of credit that has a maximum increase for the variable rate. This variable rate will be assessed based on the utilized amount and amortized out to provide a minimum payment you must pay. Similar to a credit card.
Assuming you have this same $104k available, you may opt for a home equity loan, whereas you would request up to the approved amount as a fixed loan. This loan would have a fixed interest rate and monthly payment and would be amortized over a certain fixed period of time.
I would be very careful about when, if, and to what extent you tap into your home equity.
Doing everything in your power to get your mortgage paid in full as quickly as possible will ensure that you are opening up options for yourself and your family. Having a monthly mortgage amount limits your disposable income for other purposes, and home equity products will further limit you.
I have used home equity vehicles before just to have options. I have only gone the home equity line of credit route, as I would utilize it for remodel and renovation costs.
I like this option for the purpose of building more equity into your home. However, I know many people utilize home equity to pay for their kid\’s schooling and vehicles or as a bailout to credit card debt. Be very careful how you use the equity in your home. Be sure to only spend that equity on something that will increase value, not on a depreciating asset like a vehicle, a vacation, or electronics, or to pay off or consolidate other debt.
All that said, you may be asking, which one is better?
My response is that it really depends on your use. If you know exactly what your kitchen remodel will cost and utilize the home equity loan at a lower rate to have a fixed amount provided, it will be perfect for that application. Now, if you are just trying to give yourself some additional options, you may consider a home equity line of credit instead so that you can utilize only what you need if and when you need it.
With any of these products, I would use them sparingly. You may have recently heard of Wells Fargo dropping their consumer lines of credit. This was a move commonly seen in the last downturn as banks and financial institutions tightened their belts and limited their risk by doing so.
When economic conditions are unknown, these are an easy target in either limiting the credit available to consumers or canceling the credit if not currently utilized. What could be even worse is the bank or financial institution calling the loan causing you to have to pay back the loan with cash or a loan from another institution. This can wreak havoc on someone\’s personal finances who did not have the cash available to utilize for what they placed on that home equity loan in the first place.
The moral of the story is that these home equity products can be great for short-term use, but don\’t rely on them for recurring use. Much like a credit card, be sure to never use it as a slush fund, as your emergency fund, or as a means to buy what you want when you have no strategy to pay for it.
CTA:
My call to action is to consider these products and utilize a home equity product if your options are using your credit card instead. My recommendation, though, is to plan for your purchases, plan for your remodels, and make sure that you are not just blindly utilizing credit to support your lifestyle.
