For many people, owning a home is their greatest asset. Few investments allow you to safely use the power of leverage and receive tax breaks. The homeownership rate fluctuates, but around 62% of people in the United States own their homes.
As home prices have zoomed up, the amount of equity people have in their homes has also risen. You can determine your home equity by calculating the current market value of your home and subtracting your mortgage and any other debts tied to your home.
Equity can be valuable for several reasons. It means that if you need to sell your home, you may be able to make a profit and receive cash back even after you pay off your mortgage. You can use that money to help purchase a new home or cover other expenses. Home equity also provides a cushion against becoming underwater on your loan and facing a short sale or foreclosure.
There is a difference between the total amount of home equity you have and the amount of tappable home equity. Tappable home equity is the amount of money a homeowner can access while still having 20% equity. That 20% ensures you don’t end up in a situation where all your home equity disappears. The August ICE Mortgage Monitor put tappable equity for all current mortgage holders at $11.5 trillion. Millions of mortgage holders can access at least $100,000 and some have over $500,000 in tappable home equity.
There are many reasons why homeowners might need to access their home equity, but before making the decision to do so, it’s important to ensure that it’s the right move. Here are some questions you may want to consider before making the decision:
- What will the money be used for? While knowing you have thousands of dollars in your home is appealing, it’s important to remember that money isn’t free. Any path you choose to utilize your home equity will either come with costs, dilute your equity, or both.
Accessing home equity to spend on nonessentials can be tempting, but it can also be dangerous. If you use the money to finance a lavish vacation or supplement your current lifestyle, you may want to proceed cautiously.
One common use of home equity is remodeling your home to make it more valuable or to repair it. Choose your renovations carefully to ensure you aren’t making choices that will add little to the home’s value when it comes time to sell. Internal projects like remodeling a kitchen or bathroom may make living in the home more pleasant, but they don’t always deliver a return on investment when it comes time to sell.
Using equity to pay off debt with higher interest may also make sense. Sometimes disaster strikes and you may need the money for medical debt or support during unemployment. Remember, you get to decide how much equity you want to access.
- Do you need a lump sum? Home equity products come with different terms, interest rates, and costs. Home equity loans usually have fixed interest rates, while a home equity line of credit (HELOC) typically has variable rates.
A HELOC can be accessed gradually over time. A home-equity loan or cash-out refinance will provide one large payment. You can also use a home equity instrument like Point.com to sell some of your equity to an investor. This will provide a lump sum without interest payments.
- Does it make sense to refinance your home? A cash-out refinance can put cash in your pocket and get you new terms for your mortgage. Cash-out refinancing became very popular when mortgage rates were low. The majority of homeowners still have a mortgage rate that is lower than current rates. If you are considering refinancing, ensure you understand the terms and have factored closing costs into your calculations.
- Do you plan to stay in the home for a long time? If you are planning to move relatively soon, it may not make sense to access your home equity now. By diluting your equity, you may be putting yourself in a weaker position when you put your home on the market. If you plan to stay in the home for at least another five years, that will give you time to rebuild your equity as long as housing prices continue to rise.
- Does it make sense to wait? If you don’t need funds, it may make sense to wait a little longer. Rates may become more favorable over the next year or two. However, the value of your home may also decrease. Homeowners have more options than ever when it comes to accessing equity, so it may make sense to map out the different pathways and the pros and cons of each.
Home equity can be incredibly beneficial for homeowners. While a home is not a piggy bank, it is still important to your financial picture. Even if you don’t plan to utilize your home equity now, it may be worth it to understand how much equity you have and what path you would like to take if you decide to access these funds.
