Every mortgage payment you make builds up the equity in your home. This is the portion of your home that you “own,” and you determine your equity by subtracting the amount you still owe on the home from the home’s value. While it’s not quite the same as having money in a savings account, you can still use your equity for expenses.
Learn more about how you can access your home equity and what you might use it for.
How to Access Your Equity
When you want to use your home equity, you have three options: selling your home, taking out a home equity loan, and taking out a home equity line of credit.
The idea of getting your equity from selling your home is easy to understand. You accept an offer on your home, then you get to keep any money that’s left after paying off the balance of your current mortgage and paying the real estate or closing cost fees.
For instance, if you sell your home for $300,000 and you currently owe $150,000 on the mortgage, there would be $150,000 left over. From that pool of money, you’d pay your agent and possible closing costs. The rest is yours to spend as you see fit.
Home equity loans and lines of credit are quite similar. You ask the bank to borrow against the equity of your home, but then you repay that money with interest. With a home equity loan, you borrow a lump sum of money to pay for a specific expense. It’s kind of like an auto loan. With a line of credit, you’re able to borrow up to a certain limit, but you only need to borrow what you need. The line of credit is more like a credit card.
Getting Your Next Home with Equity
Most people use their home’s equity to purchase their next home. After several years in a home, the home may have increased in value, and you should have built up some equity just from making your mortgage payments. When you sell, you can then use the equity as a way to come up with a down payment on your next home.
Some families choose to use only a portion of the equity for the down payment and use the remainder for new furniture or a fun vacation. However, you should remember that the bigger your down payment, the lower your monthly payments will be.
If you’re selling a large family home to downsize, you may even be able to use the equity in your current home to purchase the new home outright.
Making Your Home Better with Equity
Many people also turn to their home equity when it’s time to replace the roof, remodel the kitchen, or do any other thing around the house to improve it. If you’re planning to sell the home soon, these updates can help you get a better price for the home and sell it quickly. You then pay off the home equity loan with the equity you get from the sale of the home.
However, you can also use the home equity to make renovations even if you plan to stay in the home. Just remember that you’ll have to pay back the loan in addition to making your mortgage payments. Your bank can tell you what the new monthly payment would be.
Using Equity to Get Out of Debt
One of the biggest advantages of home equity loans is they tend to have lower interest rates than traditional loans or credit cards. Because of this, some people take out a home equity loan to pay off high-interest credit card debt, then repay the loan at a lower interest rate. This can make it easier to pay off debts, but there are some risks involved.
When you fall behind on credit cards, you’ll incur fees and hurt your credit score, but the lender isn’t going to repossess any of the things you bought with the credit. Taking out a home equity loan, though, ties this credit card debt to your home. If you fall behind on payments, the bank may take steps to repossess your home.
If you want to use your equity to get out of debt, you must be ready to be more financially responsible. Pay your bills on time and resist the temptation to put new charges on the credit cards that now have a zero balance.
Other Good and Bad Uses for Home Equity
While renovations and debt consolidation are probably the biggest uses of home equity for those who plan to stay in their homes, there are a few other times when people might turn to a home equity loan. For instance, you might use a home equity loan for your child’s college tuition or to get into property investment.
However, it’s not always wise to tap into your equity. You shouldn’t use it for expenses that are somewhat frivolous, like a big vacation or a new wardrobe after you’ve lost some weight. In these cases, the interest you’ll pay isn’t worth the expenses.
When it's all said and done, gaining the use of equity in your home is much better than throwing away money on rent with no return. Home equity can help you afford the things you really need but always do your research first and be wise about using it.