Many times people find themselves desperately in need of a loan to finance a new project such as a home remodeling/ renovation, starting up a new business, or just taking care of a nagging bill. Homeowners have one sure way of creating funds when they need money for such projects and that is by creating equity out of their homes.
In real estate, equity can be said to be the value of a property that belongs to you. As a homeowner pays off their mortgage, the amount of equity they have on the home increases. When the mortgage is completely paid off, a homeowner has full equity on their home. Different loan providers have different methods of calculating the percentage of home equity required for different kinds of loans. For instance, to get reverse mortgage loans offered by All Reverse Mortgage, the percentage of home equity required in your home will be calculated by considering such factors as your age, interest rate, and value of your home. Reverse mortgage loans allow homeowners to relinquish equity in their homes in exchange for money. These loans are not to be paid back with money.
The value of your equity plays a vital role in the pursuit of a loan thus the amount of loan you would be allowed to borrow is directly proportional to the amount of equity you possess. The value of your home’s equity can be known by subtracting the mortgage balance yet to be paid from the original worth of the house. This simply means the difference between the total value of the house and how much you are yet to pay. The difference obtained is the amount you have been able to pay. Home equity is a great tool for when you need to raise money immediately.
Creating equity out of your house could be done in a couple of ways; however, it is important to know that each of the methods has benefits and demerits. The methods include:
- Home Equity Loan: This is almost like a normal mortgage having a fixed interest rate. The amount of equity you have in this case serves as collateral or leverage.
- Home Equity Line of Credit: This is quite similar to the Home Equity Loan. The difference is that the interest rate here varies, it is not fixed. The amount of money to be taken out on a line of credit is solely made by the borrower, provided it’s within a limit. The interest rate here is dependent on the amount one takes out.
- Cash-out Refinance: cash-out refinance provides ones with cash while allowing them to take on a bigger mortgage.
As a prospective loan seeker or borrower, these are some of the reasons you should consider creating home equity rather than opt for the conventional way of obtaining loans from banks or other financial institutions.
- Using Equity, you can generally obtain cash with even lower interest rates than that of the regular personal loan rates/ credit cards. In May 2022, research showed that the average credit card interest rate is 16.54 percent. Meanwhile, the average home equity loan rate is 6.01 percent, and the average HELOC rate is 4.27 percent. That indeed is a clear distinction between the two.
- Equity loans cover more expenses than regular loans as more cash is given.
- One of the benefits of this method is that flexibility in payment plans is available. You can select options based on your needs and you are free to use the funds as you wish.
- The interest you pay in either Home Equity loans or a line of credit is easily tax-deductible based on the use of the money according to the IRS.
Despite the tempting advantages of equity loans, it is also not without risks. The risks are as follows:
- The main downside of this method is the obvious fact that using your home or equity as collateral, failure to make the monthly repayments for a prolonged period can result in a foreclosure of your house.
- There could be a drop in your credit score as a result of the foreclosure. This foreclosure would remain in your report for seven years, counting from the very first date of missed mortgage payment. This also impedes you from obtaining future loans or mortgages as the lender may become skeptical about your ability to pay up your mortgage debts if granted the loan.
- There is always the risk of a real estate downturn. Land as an asset can sometimes depreciate. This could cause you to acquire more loss by even increasing the price of your initial benefit.
- The best equity option depends on some factors such as how much you need to borrow and what you’ll need the money for. Hence it’s critical to analyze each option before choosing.