As an investor, you should always be looking for ways to have your money work on your behalf. However, this may be easier said than done. There are entirely too many options, with equally daunting criteria to meet. The mere thought of learning an entirely new investment approach might be too much to take in, especially while simultaneously taking on the real estate industry. Fortunately, there is one approach that a large portion of the investor population is familiar with – equity.
Equity is often overlooked, as it is a relatively unassuming investment vehicle. A lot of people are starting to regain equity in their investment properties, but they do not know how to use it to their advantage.
Some homeowners that have managed to establish a little equity may be tempted to allocate some of the wealth to immediate needs or, dare I say, wants. However, where do you draw the line? What warrants funding from the equity you have worked so hard to build up? Should you use a cash-out refinance, home equity loan or line of credit to make repairs to a subject property? What about to renovate your own home?
Unfortunately, these questions can’t be answered with a simple yes or no. While an easy answer would be nice, decisions regarding the allocation of equity are complicated and depend heavily on your particular situation. Having said that, let’s take a look at some common home equity cash-out scenarios and why they may – or may not – make sense for you:
According to Kelly Kockos, the home equity product manager for Wells Fargo in San Francisco, home improvements are the quintessential reason why most homeowners dip into their equity. More and more homeowners are realizing the benefits of allocating their equity into renovation budgets. The upside is evident, as you are essentially investing in your own property. With additional funds, homeowners can remodel kitchens, bathrooms, bedrooms and even basements. The opportunity is especially attractive if the house in question has increased in value. The larger equity cushion makes the decision much easier.
“You can leverage that equity at a low rate to improve your home and make it more comfortable,” says Justin Lopatin, vice president of mortgage lending for PERL Mortgage in Chicago. “If you can tap into equity without increasing overhead to the point that it’s not affordable or comfortable for you, that’s a good reason.”
For those looking to put their equity to work, renovations are typically regarded as the best vehicle.
Homeowners who qualify can use equity for a number of reasons. However, they are advised to exercise caution. One of the most popular uses of equity involves subsequent investments. Home equity can be used to invest for a higher return as long as interest rates remain low. If an opportunity presents itself, reinvesting your equity may be a great way to put your money to work for you.
Investing In Education
“A HELOC or home equity loan can be an attractive way to finance a child’s education because the interest rate might be lower and the maximum loan amount higher than some other types of education financing,” says Andy Tilp, president of Trillium Valley Financial Planning in Sherwood, Oregon.
While some may disagree, the use of a home equity line of credit certainly has its place. However, there is a fine line in which dipping into equity represents a risk. The ease in which new debts can be accumulated suggests that using home equity to pay off previous debts is almost futile. Though popular, experts do not recommend paying off car loans, credit cards or other personal debt. It may make sense when you run the numbers, but that doesn’t cure the problem of credit card debt. You want to make sure you are taking care of what got you into debt in the first place. Credit card debt is unsecured while a home loan is secured by your home, which explains why the interest rate is so much lower than a typical credit card rate. Essentially, freeing up unsecured debt for secured debt is a bad idea.
What It Takes To Borrow From Home Equity
With the economy on the mend, more homeowners have been awarded the opportunity of building up equity. The possibility of tapping into equity is a viable option for many homeowners. As prices rise, the use of equity may become more prominent. However, tapping into equity is not as easy as many may think, and not everyone meets the requirements to borrow from their “house bank.” Home prices rose year over year for the 22nd straight month in March, according to the S&P/Case-Shiller index of home prices. That run helped 4 million mortgaged properties regain equity in 2013 and boosted Americans’ overall stakes in their homes to over 50 percent for the first time in six years.
In order to take advantage of home equity, consumers must demonstrate that they have enough equity, a high credit score and a healthy debt-to-income ratio. Those with the appropriate credentials have the option to take out money via a cash-out refinance, home equity loan or home equity line of credit, also called a HELOC.
- Home Equity Loan: A second mortgage for a fixed amount, at a fixed interest rate, to be repaid over a set period.
- Home Equity Line of Credit: A second mortgage with a revolving balance, like a credit card, with an interest rate that varies with the prime rate.
- Cash-Out Refinance: A mortgage refinance for more than the amount owed. The borrower takes the difference in cash.
It may go without saying, but you need equity in order to borrow from it. However, the amount of equity that you have established plays a large role in whether or not you are allowed to tap into it. Lenders require a hefty amount of equity before homeowners can borrow against their home. In general, a homeowner cashing out into a fixed-rate mortgage must have at least 15 percent equity left over, or a loan-to-value ratio of 85 percent, according to rules spelled out by Fannie Mae and Freddie Mac.
Once equity has been established, borrowers must meet certain credit score requirements. For HELOCs, most borrowers with a credit score between 660 and 680 will probably qualify, but a score of 700 is preferable. For cash-out refis, generally, the lowest credit score on a home that the borrower lives in is 640, according to Fannie Mae’s standards.
The ratio between a consumer’s total debt and income is also part of the qualification equation. And again, the lower the percentage, the better. The magic number, according to Fannie Mae and Freddie Mac, is 45 percent.