Surprise bills can come up at any time forcing you to need money fast. Before you turn to family and friends, look at your homeownership. You may have a huge savings account you did not even realize you have in your home. It is called your home equity and it can help you to leverage your asset.
If you own your home, even if you have not yet paid off the mortgage completely, you can leverage the equity in your home. Their home is typically the most valuable asset of most Americans. As you pay off your residential mortgage, you build equity. Equity refers to the amount of the paid off value of the home mortgage. If you have a mortgage of $400,000 and have paid off $200,000 of your mortgage, you have earned 50 percent of the home’s equity. At 2018’s end, US homeowners had amassed $5.9 trillion in equity. You can leverage your asset to get your loan.
Leverage Your Asset: Home Equity Loans in General
You might wonder how that equity helps you. You can use your equity to refinance your home or borrow against it for a cash-out loan or establish a line of credit. Each of those three options works in a different way.
- Refinance: also called a rate and terms loan, this option lets you obtain an updated interest rate and loan terms based on the amount you have left to pay off on your original mortgage
- Cash-out: another type of refinancing loan, this lets you use up to 80 percent of your equity to access cash from the home’s value
- Line of Credit: establishes an account equal to your equity or a portion of it that you can draw money from as needed to pay for any item you need
Warning: The Lender Will Need to Foreclose on Your Home if You Do Not Pay Your Mortgage Back
That may sound like an odd warning since you would not have equity in the first place if you had not been paying off your mortgage, but many people take out a home equity loan because of a major need. It is typically a large, costly need, such as medical bills for a major emergency. It can often complicate the repayment process since by accessing the equity, you erode it. In other words, you owe that money all over again. You give up the money you already paid into the home.
Most financial lenders force you to leave about 20 percent of your equity in the home. If you take out a Veteran’s Administration loan though, you can access 100 percent of your equity. That puts you back to the first day you bought your house though. You would need to pay the whole home off again. That is a major caveat to accessing the equity. It puts you back at square one.
Qualifying to Leverage Your Asset
Qualifying to use your home’s equity comes down to more than whether you have built equity in it. You must meet multiple criteria:
- a minimum of 15 percent equity of the fair market value of your home, also referred to as a loan-to-value ratio
- a FICO credit score of at least 620
- a history of paying off debt
- a documented repayment capability
- a debt-to-income ratio of less than 50 percent
Home Equity Options
Of the three home equity options, you must choose the one that works best for you. This depends on your specific situation. First and foremost, the reason for the loan determines which home equity option to use. Other factors that influence what is available to you including your credit history, income and your home’s value.
Leverage Your Asset: Home Equity and Paying Down Debt
You can use home equity loans to obtain money to consolidate debts and quickly pay off credit cards, student loans, or auto loans. The house provides the collateral for a cash-out refinancing loan, making it easier to obtain a lower interest rate. If you need to pay off a bunch of debts, a cash-out refinance mortgage makes the best choice.
A credit card might have a high-interest rate, perhaps an APR as high as 25 percent. If you have even one card with that APR, you pay your principal debt and a quarter of it back. Obtaining a cash-out loan lets you pay off the card and pay only a few percent interests on the loan. You typically spread the payments out longer since most mortgages range from 15 to 30 years, but you make quick progress paying down your debt. The trick is to not use the credit card again once it gets paid off. Once you pay the cards off, you obtain a zero-interest or low-interest credit card for use. This lets you avoid the previous problem. You then close down the higher interest cards.
Think Twice Before Everything
Here’s the thing and I know that I am repeating myself, but I cannot stress it enough — you have to know that you can easily pay back the new mortgage. If you miss payments, you lose your home. Period. The bank will foreclose.
This may seem simple at first, but realize that you probably started out with a 40-year mortgage. You already paid into it for 10 to 15 years to build the equity you have. Now, you are erasing that equity and spending it to pay for something. Since you are taking out a new mortgage, you will get new terms. You probably will not get another 40-year term. You will have fewer years to pay it off. So, let’s assume you get 30 years to pay it off and you used 80 percent of your available equity. That means you will have higher mortgage payments than you did initially. You owe more with less time to pay for it. You could end up still paying off your mortgage in retirement.
Also, you are spending a ton of money on a single expense. If that expense pays you back, that helps. If it does not, you are losing money and you need to re-pay the mortgage. So, if you know that you can easily re-pay it, go ahead and take out the line of credit or the loan. If not, try for a different loan type.
Leverage Your Asset: Home Equity and Renovations or Major Purchases
Perhaps you need to renovate your home or want to remodel it. This can cost thousands of dollars and you will need to pay the contractor all at once. They may flow the funds through and pay the sub-contractors they use or you may have to pay the subcontractors directly, too. You will need to purchase materials for them to use.
Also, you might need to purchase a new vehicle, or have an existing vehicle modified with a lift or something else. You may need to purchase an SUV or RV for work purposes.
These large expenses that may require multiple expenditures benefit from a home equity line of credit. This revolving credit line lets you withdraw from it when needed without a new application and works better than a reverse mortgage.
Leverage Your Asset: Home Equity and New Mortgage Terms
You can also refinance your residential mortgage simply to take advantage of lower interest rates and better terms. This way you can save money in the long-term. You may end up with smaller monthly payments and a lengthy-term to repay it.
For this refinancing to work to your advantage, you need to have a superb credit score to leverage your asset. That lets you qualify for the lowest interest rates and the best terms possible. The higher your credit score, the better.
The borrowing limits are there to protect you. While a VA loan will allow you to tap 100 percent of your available equity, it is not a good idea. Your equity stems from the part of your home you already paid off. The less equity you use, the less you have to re-pay in addition to the money you already owe. This means you should use as little equity as possible.
Important Factors Regarding Home Loans
No matter what kind of loan you decide to take out, there are risks. You will also have upfront expenses.
Any type of loan application creates a hard inquiry on your credit report. That creates a temporary reduction in your credit score. It typically only ranges 5 to 10 points, but it still happens.
You will need to pay for a home appraisal, also you pay new title fees and one-quarter of the annual property taxes. These expenses you can roll these expenses into the loan. You will also get a refund on your existing home insurance and an escrow account. There is a delay though.
“We don’t want people to be extended outside their means. If they are rolling revolving debt into a 30-year fixed, yes the monthly payment goes down, but you are stretching it out over time.” – JPMorgan Chase & Co. executive director and senior lending manager Fady Semaan told Forbes
Loan Shopping Made Easier
The modern way to find a loan is to start at Loanry. The site functions as a loan mall. Just like you shop for blue jeans at a shopping mall, you can shop for a loan online. At Loanry, you can fill out and submit a form that creates a soft hit on your credit and lets you know about loans for which you might qualify. You can reduce your research by using it. All you need to do is enter your information below, and wait for potential offers within the next few minutes. Start here:
Once you have a list of potential lenders, you need to meet with each. Ask them to explain the available loan plans to you. Ask the loan officer questions to clarify the loan terms and conditions. Make sure you fully understand the following:
- the monthly payment amount
- the interest rate
- the APR points
- the finance charges
- the application, appraisal, broker, document preparation, funding, loan processing and origination/underwriting fees
Getting Ready to Apply for a Loan
You might feel ready to jump in and apply for a loan after speaking with the loan officers. Do not apply yet. You should know some things before taking out a home equity loans that loan officers may not tell you.
First, check your credit score. You requesting your own score does not affect your score. It does not create a hard inquiry. You will not lose credit score points for checking it yourself. So, make sure your credit is application ready. You can do this for free using the US government website.
What Your Credit Score Includes
You might think three digits cannot say much about you, but to a financial lending institution or creditor, it tells a long story. It goes back at least seven years. Credit score is important for this type of mortgage, same as it is important for FHA loans.
Credit score ranging
Ranging from 300 to 900, it tells the loan officers if you pay on time, if you have a lot of credit cards, if you take out too much credit and if you max out your cards – in three digits. Few people actually have a 300. That would mean you never paid anything you had taken out and you really overextended yourself. A 900 tells the bank you are a credit god or goddess. You make a lot of money, you always pay on time or early, you barely use the credit you do have and you manage your money really well.
Most people have about a 550 to a 640. That means the average person is late sometimes, pays on time mostly, uses about half of their available credit. That means there are some people who cannot get a loan, some people who easily get a loan at a great rate and the majority of people who can get a loan, but have to pay a higher interest rate to mitigate the risk of them paying late or not at all. Your credit score encompasses the following:
- your bill-paying history
- how many accounts you have and the type
- your late payments
- any collection actions
- your outstanding debt
- how long you’ve had your accounts
An algorithm determines your score based on that information. Your score gets compared with the credit performance of other individuals with similar profiles. That probably sounds unfair. You get judged by the other people who the algorithm says you share the same traits, but the system works pretty well. If you recently landed a job that pays you far more than when you established your credit, it shows when you pay back your loan even more quickly.
Boost your credit score
You can boost your score pretty quickly by paying everything on time for six months. This will bump you up by about 20 points.
You should also check for mistakes in your credit report. If you find incorrect information, you will need to file a dispute with the credit bureau from which the report came. This is because each creditor reports to a different bureau or bureaus. Some report to all three, some only to one. You need to check your report on all three because you do not know which credit bureau the bank will use. If incorrect information shows up on all three, then you need to dispute it on all three. Do not apply for a loan until the dispute is taken care of on all three bureaus, if it appeared on all three.
After you have met initially with each potential lender, rather than pick one, negotiate with many. Make them compete for your business by letting them know that you are shopping around for the best deal possible. Negotiate the fees, points and interest rate on each. Tell them what the other lenders offered and asked them to beat it.
Once you choose your bank, read the closing papers closely before you sign them. You cannot count on the bank keeping it exactly as you discussed. You must check it. If they changed the loan terms from what you had agreed to, do not sign the papers. Go back to negotiating or walk away. Even if you do sign the papers, you typically have the right to cancel without penalty for up to three days after you sign the loan papers.
You can fund your renovation project, car purchase, college tuition or any of a number of other large expenses by leveraging your home equity. Whether you just want to save money on the terms and interest on your mortgage or you need to fund a major expense, you can do so using a rate and terms refinancing loan, a cash-out refinancing loan or a line of credit. Analyze your credit and meet with loan officers after beginning your research at Loanry. You can find a home equity loan or line of credit that suits your budget, credit score, and ability to repay.
Carlie Lawson writes about business and finance, specializing in entertainment, cryptocurrency and FOREX coverage. She wrote weekly entertainment business and finance articles for JollyJo.tv, Keysian and Movitly for a combined seven years. A former newspaper journalist, she now owns Powell Lawson Creatives, a PR firm, and Powell Lawson Consulting, a business continuity and hazards planning consultancy. She earned BAs in Journalism and Film & Video Studies from the University of Oklahoma. She also earned her Master of Regional & City Planning at OU. Her passion lies in helping people make money while reducing risk.