Owning a home is a great step for growing families and anyone who is looking for a stable investment in the long run. For most of us, a mortgage is the only way to buy a house. It’s a slow, gradual way to gain home equity, with every payment getting us closer to owning the house entirely. It also offers more predictable rates than rent (due to the fact that most interest rates in the US are fixed for 30 years), and interest payments are deductible up to a point. What’s more, keeping up a stable mortgage positively reflects on your credit score.
Keeping a strong credit score is essential for financial stability and future loans that will help you fund new ventures and set you up for new loans and financing to manage. As we try our best to stay up to date with our debt payment plans, we may find complications that could negatively impact our credit. Fortunately, there are many ways to secure cash from some of our other assets, like our home’s equity. This article will explore a few ways that using your home equity can help you pay off debt.
Calculating Home Equity
Finding out how much of your home you own at any moment is a simple calculation but it's a fluid number (due to the fact that your home value and the remaining mortgage amount change constantly).. First, find out how much your home is currently worth, as it may have changed in value over the years. You can approach a real estate professional for a more accurate valuation. Then subtract however much of your mortgage you still owe, along with any other debts secured by your home.
You can increase your equity in a number of ways. Paying more of your mortgage and related interest is the main way. You can also invest in improvements for your home because they will directly increase your home’s value, thus increasing the value of your equity. Bear in mind, however, that many improvements can be more expensive than continuous mortgage payments.
How Your Equity Can Work for You
Your equity can help you in a few ways. The two best-known ways are a home equity loan—otherwise known as a second mortgage—and a home equity line of credit (HELOC). You can also explore a cash-out refinance, which allows you to take out a large sum of your current paid mortgage and replace your mortgage with another, bigger loan. As with any loan, tapping into your equity comes with pros and cons that we’ll discuss.
Home Equity Loan
Taking out a second mortgage means getting a loan based on your equity. You will rarely secure 100% of your equity; instead, expect an 80/90% loan. This arrangement comes at a fixed rate, and it uses your home as collateral. You can use a home equity loan to consolidate debt or however you want, but bear in mind that, unlike a refinance option, this is a second loan that has to be paid. These kinds of loans are best for one-time expenses where you know exactly how much you need.
HELOC
This option works as any other line of credit, but the credit available depends on your equity over your home and is only available for a period of time. It consists of two phases: drawing and repayment. During the drawing phase, which usually lasts around 10 years, you can take advantage of the line of credit. This amount is usually 85% of your equity, but it may change depending on your lender. Once the drawing period ends, you enter the repayment phase. You are no longer allowed to take out any of the available credit and have up to 20 years to pay the money you’ve borrowed plus interest. Usually, you will agree on the interest rate, and they are more flexible than standard loans.
Cash-Out Refinance
The goal for a cash-out refinance is to take out cash that was tied up as your home's equity. In this case, you also take a percentage of your existing equity, which results in a bigger mortgage. While this kind of agreement has the potential to help you settle other debts and secure some cash, it increases the length of your debt and may result in bigger interest rates depending on your original mortgage.
It is also important to note that millions of Americans are rejected from cash out refi’s every year due to bad credit scores and/or income requirements.
Pros and Cons: Should You Use These to Consolidate Debt?
These three options have very similar pros and cons. On the one hand, they allow you to access cash quickly. Moreover, they commonly have more affordable interest rates than traditional loans. They allow you to continue building equity as long as you fulfill your payment obligations and can increase your home’s value if you dedicate the loan to improving the property.
Contrastingly, they put your home as collateral, which means that you may lose the house if things don’t go your way. This is usually what makes interests more affordable, but it’s also the main reason why you should be very cautious and thoughtful before you take on these kinds of arrangements.
A New Option: Sale-Leaseback Agreements
A trend that has seen growth in recent years is the sale and leaseback transaction. Unlike the resources we’ve mentioned so far, this kind of deal doesn’t lead to a foreclosure from failing to cover the mortgage and may result in more money for you. This practice is more common in commercial properties, but homeowners have increasingly seen its benefits. Here’s how it works:
You sell your house to an investor, who then leases the property back to you. This allows you to turn your home’s equity into cash that you may use however you see fit and enter a new agreement where all you rent back your home without ever leaving. The buyer takes care of the property entirely, including any taxes and maintenance costs. Perhaps the biggest pro that a sale-leaseback agreement can give you as a seller is that your credit score won’t be affected as negatively as it would be from failing to complete your mortgage payments. It does mean, however, that though you can stay in your home, you will no longer be the proprietor.
The Right Call for You
There are many ways that you can use your home equity to work to your benefit, even giving you the necessary cash to handle your debt. Choosing to transform your home equity into cash is a delicate choice, and it shouldn’t be taken lightly. We suggest that you carefully consider the way that each option may work to your benefit, depending on your equity, credit score, and goals.
At Sell2Rent, we can help you find private investors to sell your home to, without leaving it while securing a strong influx of cash that you can use to address your debt without putting your housing situation on the line.
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