Unlocking Home Equity: Strategies For Smart Investing

Home equity is the difference between a property's current market value and the amount owed on the mortgage. There are several ways to turn home equity into an investment, including home equity loans, home equity lines of credit (HELOC), and cash-out refinancing. These options can provide needed funds without selling the home or taking out expensive personal loans. However, it's important to carefully consider the risks and potential drawbacks before making any decisions.

Home equity loans

There are a few disadvantages to home equity loans. For example, you will usually receive the full payout in a lump sum, whether or not you need the entire amount. Additionally, you will be paying more interest and draining more equity if you borrow more than you need. It is also important to note that you can usually only access 80-85% of your home equity.

However, there are also advantages to this type of loan. Home equity loans have a fixed interest rate and consistent payments, and they do not affect your primary mortgage. They are also a good option for debt consolidation as they usually have lower interest rates than credit cards.

Home equity lines of credit (HELOC)

A home equity line of credit (HELOC) is a revolving credit line that is secured by the equity in your home. It is a type of second mortgage with a revolving balance. This means that you can borrow money, pay it off, and then borrow again. It works in a similar way to a credit card, but with significantly lower interest rates. You only pay interest on the amount of credit that you use, rather than the available loan amount.

HELOCs are divided into two stages: the draw period and the repayment period. During the draw period, you can borrow money up to your credit limit and make interest-only payments. The draw period typically lasts for five to ten years. After this, the repayment period begins, during which you repay the final amount you have borrowed, with interest, over a set period, often 10 to 20 years.

HELOCs usually have no closing costs and come with adjustable rates that vary with the prime rate. This means that your interest rate could rise or fall over the life of the loan.

To qualify for a HELOC, you need to have available equity in your home, meaning that the amount you owe on your home must be less than the value of your home. Lenders will also look at your credit score, history, employment history, monthly income, and debts.

Cash-out refinancing

Determine your eligibility:

Ensure you meet the lender's requirements for credit score (typically above 620), property equity (usually more than 20%), and seasoning (often 6+ months since the purchase).

Gather necessary documentation:

Collect proof of income, tax returns, bank statements, rental agreements, property insurance, and any other required documents.

Calculate your available equity:

Determine the current value of your property and subtract your outstanding mortgage balance to estimate your available equity for a cash-out refinance.

Shop for mortgage lenders:

Compare rates, terms, and fees from multiple lenders to find the best cash-out refinance option. Be sure to disclose that the property is used for investment purposes.

Apply for the refinance:

Choose a lender and submit your application along with the required documentation. Be prepared to provide information about your investment experience and plans for the cash-out funds.

Obtain an appraisal:

The lender will order an appraisal to determine the current market value of your property and confirm your equity position.

Await underwriting and approval:

The lender will review your application, credit, income, and property information to make a decision on your cash-out refinance request. If approved, review and sign the final loan documents, pay any closing costs, and receive your cash-out funds.

Pros of cash-out refinancing:

• You can lower your interest rate: This is the most common reason borrowers refinance.
• Your cost to borrow could be lower: Cash-out refinances often have lower rates than home equity loans, personal loans, and credit cards.
• You can improve your credit: If you use your equity to consolidate debt, your credit utilization ratio (the amount of your outstanding balances compared to your overall credit limits) could drop. This can help boost your credit score.
• You could take advantage of tax deductions: If you use the cashed-out funds for home improvements and itemize your taxes, you may be able to deduct the interest.

Cons of cash-out refinancing:

• Your interest rate might go up: If interest rates have risen since your original mortgage, you'll pay more on your new loan, even with good credit.
• You could be prolonging repayments: Make sure you're not prolonging over decades, repayments you could have paid off much sooner and at a lower total cost otherwise.
• You have a greater risk of losing your home: A cash-out refinance increases your mortgage balance. Failing to repay the loan means you could lose your home to foreclosure.

Real estate investing

Home equity is the part of your home that you own outright. It is the difference between your home's value and what you still owe on your mortgage. For example, if your home is worth $425,000 and you owe $275,000, you have $150,000 in home equity.

There are a few different loan options to consider when converting your home equity into cash for real estate investing:

• A cash-out refinance allows you to replace your current home loan with a new mortgage for a higher amount. You then pocket the difference in cash, which can be used for a down payment on an investment property.
• A home equity loan is a second mortgage that allows you to receive a lump sum, which is repaid in monthly instalments over a set term of five to 30 years.
• A home equity line of credit (HELOC) is a second mortgage that works like a credit card, with a line of credit that remains open and available during a set draw period. You only pay back what you spend, plus interest, and you can reuse the credit line as long as it's available.

It's important to note that you usually can't access 100% of your home equity. Typically, you'll be limited to an 80-85% loan-to-value (LTV) ratio. Additionally, using a home equity loan for real estate investing carries risks. If you can't keep up with payments, you could default on your loan and lose your home. Furthermore, if your home's value decreases, you could find yourself underwater on your loans, unable to sell or move without paying money to your lenders.

There are several strategies for using home equity for real estate investing:

• Use your home equity for the down payment on a second home or investment property.
• "House hacking": Use an investment property loan to finance a home you both live in and draw rental income from.
• "House flipping": Buy a home with the intention of renovating and selling it at a profit.
• Purchase a foreclosed home at a low price and use home equity to fund repairs before selling at a profit.
• Real estate investment trusts (REITs): Own property with others, or own fractional shares of a property without the need to purchase, manage, or maintain it.
• Use equity from one investment property to buy another, but be aware that the performance of the first property can impact the second.

Higher education expenses

Using Home Equity for Higher Education Expenses

Overview

Home equity is the difference between your home's value and the amount you still owe on your mortgage. Homeowners can borrow against this equity to cover various expenses, including higher education costs. This can be done through a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. However, it's important to carefully consider the risks and benefits before tapping into home equity to pay for education.

Pros of Using Home Equity for Higher Education Expenses

• Lower interest rates: Home equity loans and HELOCs tend to have lower interest rates compared to unsecured loans, such as personal loans or credit cards. They may also offer lower rates than student loans, especially private student loans.
• Large borrowing capacity: Depending on the home's equity, homeowners can access a larger sum of money compared to other loan options, including federal student loans.
• Flexible usage: Home equity loans and lines of credit can be used for various expenses beyond just education. Additionally, they can be used to pay for education expenses for individuals who are not the homeowner's children or legal dependents.
• Flexible repayment options: Home equity loans offer fixed monthly payments over a set term, usually between 5 and 30 years. HELOCs provide more flexibility, allowing borrowers to make interest-only payments during the draw period and then repay the principal during the repayment period.
• Help your child stay debt-free: By using a home equity loan or HELOC, homeowners can help their children avoid the burden of student loan debt, giving them a better financial start in life.

Cons of Using Home Equity for Higher Education Expenses

• Personal risk: Taking out a home equity loan or HELOC means putting your home at risk as collateral. If you fall behind on payments, you could lose your home.
• Impact on credit: Taking out a loan or line of credit can affect your credit score and increase your debt-to-income ratio, potentially making it harder to obtain other loans in the future.
• Federal student loans may have more flexible options: Federal student loans often have lower interest rates and offer benefits such as income-based repayment plans and loan forgiveness under certain conditions.
• Qualification limits: To qualify for a home equity loan or HELOC, you need sufficient equity in your home, a minimum credit score (typically 640 or higher), and enough income to make the payments. Federal student loans may have more flexible qualification requirements.
• Closing costs: Home equity loans and HELOCs may come with closing costs, adding to the overall expense.

Tips for Using Home Equity for Higher Education Expenses

• Compare options: Consider all your financing options, including federal and private student loans, scholarships, grants, and work-study programs, before tapping into home equity.
• Evaluate your financial situation: Ensure you are comfortable with the additional debt and monthly payments. Consider your other financial obligations, retirement plans, and long-term financial goals.
• Shop around for lenders: Compare interest rates, fees, term lengths, and other loan features from multiple lenders to find the best option for your needs.
• Have a plan for repayment: Discuss with your child how they can contribute to their education costs and develop a repayment plan. Be prepared to cover the entire cost if needed.
• Pay it off early if possible: Consider making extra payments or using tax refunds or bonuses to pay down the loan or line of credit faster, reducing the overall interest cost.

Frequently asked questions