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3 Ways To Use Home Equity

3 Ways To Use Home Equity

If you are asking yourself, “should I buy a house?” you’re likely interested in building equity.

After all, your home will probably be your biggest asset. It can also be your road to wealth.

The wealth built into your home can be used in many ways, but some are much smarter than others. 

You could use it to finance a lavish trip around the world or on an $180,000 Maserati, but neither is a good decision — nor will it enable you to leverage the wealth in your home equity.

U.S. owner-occupied homes had a record $26.1 trillion of value in the first quarter of 2019, according to the Federal Reserve.

Of that, Americans held equity valued at $18.65 trillion. That leaves a lot of opportunity for a lot of Americans to borrow against their homes in the form of home equity loans.

If you’re still on the sideline wondering whether should you buy a house, this is one financial avenue that's not open to you.

Two Types Of Home Equity Loans

Home equity loans are also known as a second mortgage.

Borrowers receive all of the money at one time and can generally do with it what they choose, often to remodel the house or to finance a business. 

Borrowers qualify for a second mortgage in much the same way they did for the first. Your credit report and debt-to-income ratio will be reviewed.

Once you receive the money, you’ll begin making monthly payments based on the terms and conditions of the loan. It’s very similar to what happened the first time you wondered: “should I buy a house?”

Home equity lines of credit, or HELOCs, are a little different. You are still borrowing against the equity in your home, but the terms and conditions — and how you receive the money — are different from a home equity loan.

You draw the money out like a credit card rather than as a lump sum. Most HELOC loans are divided into a period when you are drawing money out and a separate payback period.

You’ll probably have interest-only payments during the drawdown period.

A major remodeling is also a good use for a HELOC when you periodically need to make large payments to contractors or buy large amounts of materials if you're doing the work yourself. 

Building equity for wealth is by far the best reason to say yes to home ownership, as the money is flowing into your bank account rather a landlord's account. 

Smart Ways to Use Home Equity

Both loan types offer lower interest rates than credit cards or personal loans. For that reason, even when spending money on themselves rather than leveraging it into more wealth, homeowners tend to use the funds to pay off high interest credit, personal and medical loans. But there are better ways to spend your home equity funds.

  • Invest to build more wealth. You could become the landlord instead of the renter by investing in rental property. Another frequently made investment is in a business. Innumerable entrepreneurs have used their equity to start a business. 
  • Remodeling that adds value. This one can pay you twice. Many remodeling projects don’t immediately increase a home’s value. But you find value by enjoying the improvements for several years before selling. Those improvements almost always appreciate in value faster as time goes by. In a few short years, your home is worth considerably more when you do sell or when you again borrow on the new equity your home continues to build. 
  • Emergency expenses. An equity loan can fill in during a job loss, replace a worn-out roof or see you through most other emergencies. After all, that is one of the advantages of building wealth with your home equity. 
  • Bonus: pay off high-interest debt by consolidating loans. Paying off credit cards with high interest rates won’t necessarily build wealth for you. But lower monthly payments can stop a vicious cycle of borrowing even more to make those high payments. Just be sure not to run the credit card balances back up.

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