Buying a home is a major achievement with far-reaching consequences.
In addition to homeownership, owning property transports you into the world of investing.
While you might already know about equity and how it increases in direct proportion with home prices, there might be some tidbits that you’re not totally familiar with.
As a new homeowner, here are some of the key points to know about home equity, how it works and most importantly, how to make it work for you.
Home equity basics
In the simplest of terms, home equity is the current property value subtracted by how much the homeowner owes on the home. The remaining balance, aside from the loan obligation, is equal to the equity a homeowner possesses.
As a major financial asset, homeowners can leverage their home equity to borrow additional money beyond the mortgage.
Lenders can limit how much home equity you can hold to about 85% to 95%.
Home equity loan
With historic rises to home prices, many homeowners have accumulated large amounts of equity in just over a few short years.
Credit thresholds vary from lender to lender. A score in the mid to high 600s is ideal.
Another major consideration is the applicant’s debt-to-income ratio. As it sounds, this is a comparison between how much debt the person holds versus how much they have to pay it off.
You can take your monthly expenditures and divide by your monthly income to figure out your debt-to-income ratio.
Home equity loan benefits
As you might know, interest rates have crept up a little during these changes to the economy. A home equity loan, however, features low interest rates that can lower a borrower’s financing costs over the long run for big-time savings.
If you borrow through a home equity loan, you will also enjoy the low interest rate over a longer period of time. Home equity loans can be paid over a 20-year period for a low monthly repayment.
In addition to these savings, home equity loans have fixed interest rates, unlike other lending programs in this category.
Borrowers can also look forward to tax incentives. If, for example, you use the borrowed money to make home improvements, you can qualify for a tax deduction.
Possible drawbacks
Since your home serves as collateral for the loan, things can get dicey if you default on payments. The lender will have authority to repossess the home in this absolute worst-case scenario.
A home equity loan can provide an immediate boost in cash assets. At the same time, this means that your monthly expenditure will increase as you make your monthly payments.
Finally, to reap the financial benefits of a mortgage equity loan, you will pay a closing cost for the processing of the loan. This cost can be built in.
