If you own a home, you may find yourself in a financial catch-22 of being cash-poor and house-rich. According to the Federal Reserve Board, nearly 47% of household assets are tied up in the primary residence.
While homes can be great investments, they can also hoard cash that you might need for something else.
Here are two ways to get at that cash and some tips on what you should use it for.
what is home equity?
Equity is the value that you own in your home. If you have a mortgage, equity is simply the value of the home (determined by market price) minus the amount you owe. As the value of your home increases or as you pay off your mortgage, your equity grows.Home equity loan
A home equity loan, also known as a second mortgage, involves borrowing money that you already paid into the house. You can take out a loan for a fixed period of time with a fixed payment schedule.Home equity line of credit
In contrast to a home equity loan, a line of credit is more like opening up a credit card with your house as collateral. The value of the home (and usually the percentage of the value that the creditor is willing to lend on) minus the mortgage determines the credit line. That number represents the amount you can borrow at any one time.Other factors like those on your credit report help the lender determine your ultimate line of credit. Repayment schedules for home equity credit range from fixed to variable; likewise, rules regarding minimum balances will also vary depending on the lender.
tips on using home equity
Pay off credit cards
A lot of guys pay off their high-interest credit cards with their home equity. This is a sound idea, which essentially consists in swapping high-interest debt for low-interest debt. Better still, interest on home loans is tax deductible. The danger in paying off your credit cards with equity comes if you do it too often. Doing it once can help you get back on track, but doing it every few years means you'll never have a chance to build equity and make money on your investment.Invest in home improvement
Home improvement is a way to take equity out and (hopefully) increase it. Of course, the success of your plan depends on how much value the improvement really adds. If you're adding a single element to your home, you'll probably use a home equity loan. But if you're making a series of improvements over time, it's best to consider the home equity line of credit.Save toward retirement
Home equity is often the best way to fund a retirement, so the more you have, the better. Retirees with significant but not substantial savings often make retirement work because they own their home outright. That means no more mortgage payments, which reduces cost of living. For retirees who own all or most of their home but have less in savings, there is the opportunity to cash out by selling and buying a smaller home or condo.Finally, retirees who own their homes outright but are cash-strapped can use a reverse mortgage (essentially letting the bank buy the house back while they live in it). The point is that building equity is always a good thing, but the more equity you have, the more options you create.
Invest in stocks/property
There's a high temptation to use equity that is "just sitting there" for investments. A common investment is income property, but stocks are also a possibility. People who own their homes outright are probably best-suited to take this risk because they won't find themselves overcome by a series of loan payments. If you have a mortgage and you take out equity to buy rental property, you have three loans to repay. Two are manageable; three can be a disaster. If you choose stocks over income property, you may avoid loan payments, but your risk of losing everything goes up.Pay off medical/education bills
Medical bills can often be as crippling as the illness. While taking home equity out to repay those bills doesn't make you money, it can ease the financial burden by lowering your interest rates.By contrast, paying for your education can be a great way to use your equity to invest in yourself. But before you take out a home equity loan, make sure that the rate you'll be paying is lower than the going rate for student loans.
use equity to your advantage
There are a lot of good things that you can use your home equity for, even if they don't appear on this list. What's important is that you don't use your home equity to buy consumables like a vacation or a nicer car.And even if you use your home equity wisely, you must always remember that you are postponing your debt, so ultimately, you have to make your choice knowing that you could end up paying more in the long run.
Resources:
http://realtytimes.com/rtcpages/20000203_financial.htm
http://www.fool.com/homecenter/refinance/refinance07.htm
money.cnn.com
http://www.bankrate.com/brm/news/bank/20030801a1.asp?prodtype=loan
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