Home equity can provide you with a measure of financial freedom. You can borrow against this equity to help pay for your children's college education or fund a major kitchen remodel.
It's important to remember that home equity loans or lines of credit use your home as collateral. This means that if you miss payments on a home equity loan or home equity line of credit, your lender could take your home from you.
Fortunately, we've gathered some information to help guide you on this financial endeavor.
Using your home equity
Two options to borrow against your home's equity are taking out a home equity loan or a home equity line of credit.
With a home equity loan, you receive a lump sum payment for whatever amount you borrow, based on the amount of equity you have available in your home. You then pay back the money you borrow, plus interest, each month, much like you do with your first mortgage.
A home equity line of credit is considered revolving credit, like a credit card. Your existing home equity determines the size of the line of credit available to you. You can then borrow up to that maximum line of credit. You do have to pay back the amount of money you borrowed, with interest. If you have a home equity line of credit of $100,000, and you borrow $10,000 to pay for a bathroom renovation, you'll have to pay back that $10,000 in monthly installments. You'll still be able to borrow up to $90,000 more before maxing out your credit.
Of course, some uses of home equity are better than others.
For instance, if you take out a home equity loan or home equity line of credit, it is usually smart to use the funds to pay for a major home improvement project. That is because if you improve your home, you'll also be increasing its value. This, in turn, boosts the amount of equity you have in your residence.
Consider investing in a home-improvement project that boosts your home's value. Kitchen updates and the addition of bathrooms and master bedrooms usually add to the value of a home. Certain cosmetic changes such as new carpeting or landscaping might not.
Sometimes it can make financial sense to use a home equity loan or line of credit to pay off your credit card debt. That is because the interest rates attached to home equity loans or lines of credit are usually lower than are the ones that come with credit cards. It is better to pay back a $50,000 home equity loan with a rate of 6 percent than credit card debt with a rate of 17 percent, a figure not overly high for standard credit cards.
Again, caution is in order: If you do use your home equity to pay off your credit card debt, it's wise to stop using that credit card to avoid additional debt in the future.
It might also make sense to use your home equity to make an investment that will pay off for you in the long term. For instance, some homeowners might tap their home's equity to invest in rental property that will both generate monthly rental income and, hopefully, grow in value over the years.
There are potential drawbacks with borrowing against your home equity, the most serious is the potential to lose your home.
If you miss your credit card payments, you may face a penalty and a hike in your interest rate. However, if you cannot make your payments on a home equity line of credit or loan, your lender could take your home. Only borrow against your home equity if you are certain that you'll be able to pay back the loan on time.