How to Use or Not Use Your Home’s Equity
As a Los Angeles Homeowner you most likely have a good amount of equity in your home if you have owned it for at least 5 years. Prices of homes in Los Angeles have gone up substantially over the past few years (even over the past few months) so your home’s value shouldn’t be overlooked. The equity you hold in it can be used as a resource to help cover certain expenses. Here are some expenses that you could use and should never use your equity for:
Home Improvements - GOOD because you are improving the asset (your home) underlying the loan.
Car Loan - GOOD/BAD If you can pay it off in a few years but you wouldn’t want to be paying it off during the life of the loan (30 years).
Funding a Business - BAD - Not a good idea as starting a new business is risky enough.
Education - GOOD - The interest rate on a home equity line of credit is likely to be lower than a personal loan but bear in mind that interest on a HELOCs is no longer tax-deductible unless the loan is used for home improvement or repair.
Debt Consolidation - GOOD/BAD Paying off a high interest rate credit card through your home’s equity could save you a lot in interest, but this is only a good call if you can change the behaviour that got you into trouble in the first place.
Emergency Medical Expenses - GOOD - If you have used up your emergency and can afford the monthly payments then this can be a good option.
Investments - BAD - If your investment goes South, you don’t want to be paying it off for years and risk your home as well.
There are 2 main types of loans using your home’s equity. A Home Equity Line of Credit (better known as a HELOC), and a Home Equity Loan. The best choice for you will depend on interest rates and what you need the money for.
Home Equity Loan
A home equity loan is a fixed-term loan granted by a lender to a borrower based on the equity in their home. Home equity loans are often referred to as second mortgages. The borrower applies for a set amount that they need, and if approved, receives that amount in a lump sum upfront. The home equity loan has a fixed interest rate and schedule of fixed payments for the term of the loan. A home equity loan is also called a home equity installment loan or equity loan.
A Home Equity loan may make the most sense for a fixed expense—say college tuition that you might want to pay off over a number of years.
Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) is a revolving credit line. A HELOC allows the borrower to take out money against the credit line up to a preset limit, make payments, and then take money out again.
A HELOC allows a borrower to tap into the line as needed. The line of credit remains open until its term ends. Since the amount borrowed can change, the borrower's minimum payments can also change, depending on the credit line's usage. A home equity line of credit is generally used for recurring items, like home renovations, which may require frequent and varied withdrawal amounts.
Some people aren’t comfortable with the HELOC’s variable interest rate and prefer the home equity loan for the stability and predictability of fixed payments and knowing how much they owe.
However, if you're uncertain about the amount needed and you're comfortable with the variable interest rate, a HELOC might be your best bet. As with any credit product, it's important not to get overextended and borrow more than you can pay back since your home is the collateral for the loan.
One thing you should never consider using your home equity for is investing. Stocks, bonds and mutual funds fluctuate in value, and you wouldn’t want to risk losing your home if the return on your investments is not sufficient to cover a new mortgage, loan or line of credit.
If you have any questions, please don’t hesitate to call us or ask us for a mortgage lender referral.
