Equity … What is it and what can you do with it? We’re talking about three different types of equity and multiple ways to put it to work for you.
Home Sweet Equity Home
You’re likely already familiar with home equity—that’s the dollar amount your home is worth over and above what you still owe on your mortgage or other home-secured loans. If you sold your house today, it’s what you would pocket minus taxes and fees. You could use it as a down payment to purchase another home, or to kick start an investment, or any other number of things.
What’s neat though about home equity is that you don’t have to sell your house to leverage the equity you have. In fact, there are three different ways you can borrow the cash value within your home while keeping your roof over your head.
Home Equity Loan
The most straightforward of the options, the home equity loan, is simply a new loan that places a lien against the equity in your home. It’s typically distributed as a lump sum and paid back in fixed monthly payments. Because the loan is secured by your home, it’s less risky than a personal loan and normally has lower rates. It also has terms comparable to a mortgage, which can make for very manageable payments on even a significant loan principal. There can be tax advantages to taking out a home equity loan or line of credit instead of a personal loan, but you should consult a tax advisor if that’s your motivation.
A home equity line of credit (often abbreviated as HELOC) takes advantage of your home equity the same way, but instead of borrowing a lump sum, the open line of credit functions almost like a credit card. You take advances as needed against the total credit line (like the limit of your credit card) and your monthly payments vary depending on the balance of the loan. Unlike a credit card, the interest rate is usually a whole lot lower.
This is a nice option if you anticipate ongoing expenses but don’t need the entire amount at once and maybe aren’t sure exactly how much you need to borrow. You only pay interest on what you use, so you don’t need to worry about borrowing more than you need.
Cash out Refinance
Option three isn’t quite as common as the first two. Think again about what home equity is. It’s the difference between the remaining principal and interest on your mortgage and what your house is worth. A cash out refinance is simply refinancing your mortgage so that your principal is more than what you owe. When the new mortgage is closed, a payment goes to your old mortgage to satisfy what you owe and what’s left over goes into your bank account.
Here’s an example. The home you own is worth $200,000. The balance on your mortgage is $140,000. You refinance your mortgage for $160,000, pay off the $140,000 you owed, and have $20,000 left in cash for your needs.
There are some limitations with cash out refinances. Lenders typically won’t lend you more than 80% of your home value. Even if they would, less than 20% equity normally triggers the need for Private Mortgage Insurance (PMI), which is an extra expense on top of your mortgage that isn’t doing you any good. What’s nice about this option is that you only have one loan instead of a mortgage plus a home equity loan or line of credit.
Equity in Your Driveway
Think equity is limited to homeowners? Think again. Whether you own your home or not, there may be a nice little chunk of equity parked in your driveway.
We just talked about cash out refinances for your home, but did you know you can do the same thing with your car? You can do this for vehicles you own outright or that you’re still paying a loan on as long as there is equity in the vehicle. If you don’t owe anything on the car, the equity is the vehicle’s full value. If you have a loan with a balance, the equity is the value of the car over and above what you owe.
So why would you want to refinance your car, likely extending your term instead of just getting a personal loan? One word: rates. Auto loans almost always have lower interest rates than personal loans because they are secured by the vehicle. That’s the power of equity. It’s something with real value that reduces the risk to the lender. Because it’s a less risky loan, the interest rate is lower.
Not all lenders will do cash out refinances for autos, but we do at GOLD, and we’ll finance up to 100% of the value of the vehicle.
Equity in Your Bank Account
There’s one last type of equity I want to talk about today, and that’s equity in your bank account. You can put your own money up as collateral for a loan, making it a no-risk loan for the lender. Why on earth would you want to borrow against money that’s already yours? While this is a more extreme situation, it’s a great way to rebuild credit after putting yours through the ringer.
At a certain point, a credit history becomes too risky for a lender to give a loan to someone, no matter how much we’d like to help. The best way to rebuild a credit score and start recording positive credit history is to get a loan and make every single payment on time. But how do you do that if you’re too risky to lend to? A secured loan.
At GOLD, we offer these types of loans secured by savings or a share certificate. Like the other options for tapping into equity, these loans have attractive interest rates. These loans can also make a real difference in taking steps to rebuilding credit.
Your Equity Can Take You Places
Did you know about all these different types of equity and the options for borrowing against them? Whether you’ve got a lot of equity or a little, there are ways you can you leverage it to get closer to your financial goals.
Want to talk about your own equity options? Give the lending team a call for personal help: 484-223-4216.
About Janet Weinhofer
Jan is the VP of Lending at GOLD. She directs and coordinates all lending activities within the credit union, ensuring compliance with lending policies. She ensures her team provides friendly, professional, timely, and personal service to all our Members. Jan is proud to be part of GOLD’s mission to empower our Members to achieve personal financial success.
Better Borrowing - February 18, 2020
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