When you sell your home, if you have made money on the property, you can enjoy a large financial windfall. But until you sell your home, your equity is locked up in the property. That is, unless you decide to get a home equity loan or home equity credit line (HELOC) and tap that equity.
These are the two types of second mortgages that allow homeowners to draw the equity out of their home and to use for what they like.
If you are thinking about pulling the equity out of your house in 2017, consider these great uses for it:
#1 Make Home Renovations
Many financial experts recommend only pulling equity out of your property to make renovations. The idea is to make substantial improvements on the home that will lead to a higher resale value in the future.
What kind of improvements should you make? Home experts say that these types of improvements with home equity can result in the highest return on investment.
- Redo the kitchen: New flooring, counter-tops, sink, cabinets and appliances can add a great deal to resale value. Many people looking at a home go to the kitchen right away when they are looking at buying a home.
- Add on a room: If you add usable square footage to the property, this can be a very good use of your equity.
- Upgrade the master bath: Putting in a new shower, sinks, toilet and flooring can really increase resale value.
#2 Pay For College Tuition
One of the advantages of a home equity mortgage or a HELOC is that you will be paying a fairly low interest rate. This can be useful for paying for college tuition. Rather than paying high interest on a credit card, it can make sense to pay for some of your children’s college tuition with your home equity.
#3 Pay Off Debt
Paying off debt with home equity is controversial in some quarters, but we think that it makes sense if done right.
If you have $20,000 of credit card debt that you are paying 15% interest on per year, you could pull cash out of your home, pay off the debt, and pay 5% per year on the debt. That is a huge interest savings!
The danger is if you use the opportunity to have free credit cards again to run up more debt. If you do, then you may not be able to tap your equity again to pay them off. Plus, you now have a second mortgage on your home you have to pay, or you lose the home.
#4 Invest in Real Estate
Another popular thing to do with equity this year is to buy investment properties. If you buy properties under market value, you may be able to earn 10% or more per year on your properties, and easily pay off the loan on your home.
It is important to invest your equity wisely in properties because if they properties do not produce income, you have to still pay that second mortgage.
Types of Second Mortgages
Home Equity Loans
A home equity loan allows you to pull out a lump sum of equity form your house. The rate is fixed, so it will be easy to work this into your budget. Of course, it has to be added onto your mortgage payment.
It is a one-time lump sum, so this type of 2nd mortgage is a good fit for a major project or one-time expense.
A home equity mortgage offers you a fixed rate, and the interest is normally tax deductible for most Americans.
On the down side, you will need to pay interest immediately on the entire sum. And, tapping all your equity at once can cause problems if property values decline. You could then owe more money on your home than it is worth, which makes refinancing very difficult, and also very hard to sell.
Home Equity Line of Credit
A HELOC is similar, because you are also tapping your home equity. But the difference with a line of credit is that it works like a credit card. You are given a line of credit by the lender of, say, $50,000. You can spend up to $50,000 in a certain time frame, often five or ten years.
You then need to pay back that amount over time. In the draw period at first, you will usually pay only interest on the money. But later, you will need to pay interest and principal.
A consideration with a home equity credit line is the rate is adjustable. It can rise or fall depending upon what interest rates are doing in the markets. Some people like paying the lower rate, but others do not like the unpredictability of the variable payments.
Some people like to get a HELOC for expenses that come in stages, such as home improvements that you are doing over time. An advantage here is you only pay interest on the money you have pulled out.
The Bottom Line
Getting a HELOC or a home equity mortgage can make great sense if the money is used wisely. If for example, you use the money to make improvements on your home that lead to a higher resale value, pulling out the cash can be a great idea. It also can work well with cash flowing investment properties.