Life is full of big-ticket items and using your home as a financial tool opens many possibilities to pay for great expenses such as college, weddings, and home remodeling.
One of the many benefits of owning a home is the ability to borrow against your equity, which is the difference between your home’s current value and existing debt balance. Understanding how you can unlock this value begins with finding the right home equity borrowing option for you.
Home equity calculations
First, lenders will need to evaluate your qualifications and how much you’re likely to borrow. To do this, they use a calculation called the loan-to-value ratio, or LTV. This value is based on the equity in your home, and with a few calculations you can determine your own LTV.
First, determine if you have enough equity. Then, calculate your LTV. (The LTV% = (loan balance/home value) x100). If you have an LTV of less than 80%, you may be approved for home equity financing.
2 types of home equity financing:
- Home equity line of credit. You can refinance your home with a home equity line of credit, or HELOC, which works kind of like a credit card. A HELOC allows you to withdraw money and make even daily or weekly payments. Interest rates for a HELOC are initially lower than fixed-rate home equity loans. HELOCs are usually adjustable rate, though some lenders may convert that into a fixed rate. When you’re approved for this line of credit, the lender will determine the “draw period,” which is typically the first 5 to 10 years of the loan. You can borrow as much as you want within the line amount, and, like a credit card, make minimum and interest payments. During the repayment period, which may last up to 20 years, you can’t take out additional funds and must continue to pay off the balance.
- Cash-out refinance. A cash-out refinance is useful because you can secure a lower interest rate on the new loan. This is especially helpful if you plan to use the loan to consolidate debt. The higher your FICO score, the more likely you’ll receive a lower interest rate for the refinance. A cash-out refinance works by replacing your current mortgage with another one worth more than what you owe on your house. You receive the difference in cash. Of course, like other loans, you must have a certain amount of equity amassed to qualify, and lenders limit the amount cashed out between 80% to 90% of your home’s equity.
Home equity financing can be great tools to help you access more funds for needed expenses. While this kind of financing may not be for everyone, they are often one of the most economical ways to create cash flow, with interest rates typically below credit cards and personal loans. If your home has increased in value since it was purchased, consider unlocking your equity through home equity financing.