Tempted to Borrow From Your Home's Equity? Here's What You Need to Know
Did you know that the average mortgage holder has $185,000 home equity? This past year’s record-setting housing prices have dramatically increased the amount of home equity the average American homeowner holds. This means the temptation to borrow against this equity is much greater than it has been in recent history. But before you tap into your home's equity, understand the options you have and how each may impact you:
There are three ways to access your home's equity.
- Cash-out refinancing: This option allows individuals to refinance an existing home loan, taking out cash, and replacing the original loan with a new larger one. This option may be tempting before interest rates increase if your current mortgage rate is higher, but cash-out refinancing may increase your monthly payments making it an undesirable option for you.
- Home equity lines of credit (HELOC): This option to refinance your home may be tempting to someone who only needs a small portion of their existing equity. A HELOC is a second mortgage which may reduce your principal payment, but at a higher interest rate than your first mortgage. What's essential to remember that a HELOC is another mortgage on your home, and often has revolving interest rate. Consult your mortgage professional so you understand how HELOCs work and how it will impact your situation.
- Reverse mortgages: This option allows those aged 62 or older to borrow against the value of their home and receive funds as a lump sum, fixed monthly payment, or line of credit. Taking out a reverse mortgage means spending a significant amount of the equity that you’ve accumulated on interest and loan fees. Reverse mortgages are not legal in every state, so check with a mortgage lender to determine if you will qualify for this type of mortgage basing on your home's location.
Before considering any of these three options, it’s important to remember that lenders typically require you to maintain 20% equity in your home to avoid paying PMI (property mortgage insurance). Here are a few more considerations before borrowing from your home's equity:
- Because your home is used as collateral for borrowing against your equity, there is a risk you can lose your home through foreclosure if you are unable to make your new loan payments.
- Some options for borrowing against your home equity require you to pay this debt off immediately and in its entirety if you sell your home, like with your first mortgage's requirements.
- Home equity loans may require you to pay closing costs, unlike if you were to utilize a personal loan instead. These costs may range from 2-5% of the loan amount.
- If you still have a primary mortgage, you will have to pay two mortgages after borrowing against your home's equity, which reduces your disposable income.
Although it may be tempting to borrow against your home’s equity especially as home prices hit record highs, it may not be beneficial to your long-term financial security. Your financial and mortgage professionals can help you determine if a home equity loan is appropriate for your situation and how this type may impact you.
Important Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
LPL Tracking # 1-05265292
Sources:
https://www.investopedia.com/personal-finance/home-equity-loans-what-to-know/
