In an economic climate plagued by rising inflation and disrupted stock market performance, many of FDM’s clients have found themselves looking for more (and sometimes, detrimental) ways to make ends meet. While many have smartly leveraged the equity in the home, others have relied on credit cards and personal loans. As we all know, taking on more consumer debt to pay off existing consumer debt is akin to “robbing Peter to pay Paul.”
Today’s homeowners have an important choice to make- Through which avenue or vehicle are they going to position themselves to overcome these tough economic times, and many are simply making the wrong decision. In this post, we will break down what home equity is and how to leverage those funds which still maintaining an excellent credit profile and maximizing tax savings.
Simply put, home equity is the difference between what you currently owe on your mortgage in comparison with what your home is worth in the market. Equity is accumulated in two (2) primary ways: First, through paying down your principal via your regularly scheduled monthly mortgage payments, and secondly, through your home’s natural appreciation in the market.
As a practical example, let's assume you initially purchased your home for $500,000 and put a 20% down payment, meaning your initial mortgage amount was $400,000. Through your regular monthly mortgage payments, you’ve now reduced your mortgage balance to $300,000. During the years in which you’ve been paying down your mortgage balance, your home's value has increased from $500,000 to $600,000. In this example, you would now have $300,000 in home equity.
Beware not every example of home equity would look as rosy as this. In some declining markets, real estate has no, or sometimes even negative, appreciation. In this instance, the only equity you might have is the equity that resulted in principal reduction through your regularly scheduled mortgage payments.
A real estate professional or lender like Fidelity Direct Mortgage can assist you in securing a formal appraisal on your home to accurately determine how much equity you have currently.
If you're one of the millions of homeowners who have seen a significant increase in their property value, chances are high that you have more equity sitting in your home than you might think. Home equity can be used in many different ways to assist you in getting to a better economic situation. Here are just two ways you can leverage your home equity:
Home equity loans are essentially a second mortgage on your home. Homeowners simply capitalize on a portion of their home equity through borrowing that equity. Home equity loans have multiple advantages, including (generally) a much lower interest rate than a comparatively sized personal loan, and also, tax deductions for interest that you wouldn’t ordinarily have on non-secured, non-tax-favored debt.
A HELOC is similar to a home equity loan, but instead of getting a large sum of money at one time, a HELOC is more like having a credit card (or line of credit) that is attached to your home. A HELOC is a revolving line of credit (with a maximum credit line to be determined by your home’s existing equity), and can used when and as the homeowner sees fit. HELOCs typically have lower interest rates than credit cards or personal loans, and they're also tax-beneficial when used correctly.
HELOCs are generally bifurcated into two periods: a draw period when you are authorized to borrow (generally 10 years), and a repayment period to pay back what you’ve borrowed (generally 20 years).
Homeowners looking for ways to pay for rising costs in today’s economy should strongly consider turning to their homes - and the equity they've accumulated - as a tax-favored borrowing alternative. As we’ve highlighted, home equity can be used in multiple ways, including a home equity loan or a HELOC. And if used for eligible reasons, the interest the homeowner pays on these credit forms may be tax-deductible for the year it was used.
Should you have any questions about your home’s equity, or how to properly leverage it, reach out to your preferred FDM Loan Advisor today.