How to Tap Into Your Home Equity for Life’s Biggest Expenses
Learn how home equity loans and HELOCs work, and when they may be a smart financial option.
If you’ve been paying your mortgage for a while, you’ve probably built up some equity in your home.
Maybe you’ve heard of a home equity line of credit (HELOC) or home equity loan, but you might not understand why it may be an option for you. Here’s an introduction to home equity and how you can use it to finance your life events.
What is Equity in a Home?
The definition of home equity is the difference between how much your home is currently worth (its market value) and how much you owe on your mortgage(s). Here’s a quick example to help you figure out how much equity you have:
- Your Current Home Value: $200,000
- Minus Your Current Mortgage Balance: $150,000
- Equals Your Home Equity: $50,000
How You Can Use Home Equity
Mortgage lenders allow you to borrow against your home equity through products like home equity loans and home equity lines of credit, using your home as collateral. These home equity loans are usually in addition to a mortgage, which is why they are sometimes referred to as second mortgages. The general guideline is that you can borrow up to about 85% of your home’s equity. You can use home equity funds for many major expenses, including:
- Home improvements and repairs
- Debt consolidation
- Weddings and milestone celebrations
- College tuition and education expenses
- Unexpected medical or emergency costs
How Does a Home Equity Line of Credit Work?
A home equity line of credit, or HELOC, gives you access to a revolving line of credit during a set draw period, typically 5-10 years. This is similar to a credit card, in that once you pay off what you’ve borrowed, you can borrow more. For example, if you take out a $6,000 HELOC and then pay $3,500 back toward the principal, you’ll have $2,500 in available credit. Once the draw period ends, the repayment period begins. With a HELOC, the interest rate is variable and your interest-only payments are based on the outstanding balance on the account.
What is a Home Equity Loan?
A home equity loan allows you to borrow a lump sum of money, similar to a conventional mortgage. A home equity loan may be a good option if you prefer predictable monthly payments, a fixed interest rate, and need funds for a one-time expense, such as a large renovation or debt consolidation. In contrast to a HELOC, you can’t re-access money once you’ve paid back the principal.
How to Get a Home Equity Loan or Home Equity Line of Credit
When applying for a loan, lenders typically review several factors when you apply, including:
- Debt-to-income (DTI) ratio: How much of your income goes toward existing debt. Typically, the lower your DTI, the greater chance you have to qualify for a home equity loan or HELOC.
- Loan-to-value (LTV) ratio: The overall amount you will owe on your mortgage divided by your home’s current market value. Typically, the lower the ratio, the better your chances of qualifying. LTV ratios generally need to be 85% or below to qualify.
- Appraisal: Confirms your home’s market value.
- Credit history: Helps determine eligibility and interest rate
Building up equity in your home is like putting money in the bank for a rainy day. If you need extra money to pay for your children’s education, make home improvements, or pay for unforeseen expenses, tapping into your home equity could be a good option.
Ready to see how much you may qualify for? Use our home equity loan calculator, explore current home equity loans and HELOC rates, or visit a First American Bank branch for more information. We are always here and available for any questions you may have.