One great benefit of being a homeowner is the access you have to equity. Equity in a home refers to the portion of your home’s value that you own free and clear. This simplified calculation can help you see how much equity you have in your property:
Home Equity = Current Market Value of Your Home (-) Your Mortgage Balance
And as you make your mortgage payments, the portion that goes toward your principal balance adds to your equity.
Of course, equity is not always positively linear or guaranteed. If your property depreciates—either through neglect or general property value decreases—you could potentially have negative equity (you owe more on the property than the property is worth). But more often than not, as you pay down your mortgage and take routine care of your property, you have the potential to build equity.
When you first purchase a home, the rate at which you build equity is as its lowest, as a major portion of your payment during this phase goes toward interest. But as you move further along in the repayment process, the portion of your payment that goes toward the principal relatively increases, thereby accelerating your equity building. A mortgage amortization calculator can help you visualize this process.
How to Build Equity in Your Home
Having home equity can bring a sense of financial security and open up more opportunities. Consider these ways to best build equity in your home.
- Choose a shorter loan term. When paid on time and in full, a 15-year mortgage can typically help you build equity faster than a 30-year mortgage because you’re paying less interest over the length of the loan and accelerating your progress toward owning your home free and clear.
- Start with a larger down payment. Your down payment can translate into equity because you’re automatically reducing your loan amount off the bat. The larger your down payment, the more equity you will have to start off with.
- Improve your home. Upgrading outdated styles, appliances, and even landscaping can help increase your property value, thereby increasing your equity. Maintaining and caring for your home can also help you maintain and build equity.
- Make extra mortgage payments. You can make principal-only payments on top of your monthly mortgage payments to help increase your equity faster. Even making one extra payment a year can significantly pay down your principal, and further lower your mortgage balance.
What is a HELOC?
One of the best financial opportunities that home equity can offer is access to a home equity line of credit (HELOC). This financial product is a revolving line of credit — similar to a credit card — except the homeowner is borrowing money against their home’s equity. Here are some key definitions of HELOCs that are important for homeowners to know:
- Draw period. Unlike a lump-sum loan, a HELOC offers the homeowner the opportunity to borrow, repay, and borrow repeatedly during the HELOC’s draw period. The draw period for HELOCs typically lasts about five to ten years. During this time, the borrower is typically making interest-only payments on the funds they borrow, though some lenders may allow you to make payments on the principal as well.
- Repayment period. After the draw period, the borrower transitions to the repayment period, which involves a similar process to a traditional loan. The borrower makes monthly payments—comprised of principal and interest—until the loan is repaid in full at the end of the agreed-upon term, usually an additional ten to 30 years.
- Interest rates. The HELOC’s interest rate is typically variable, meaning that it susceptible to change (usually dependent on the economy). This can make your payments increase or decrease, depending on which way the rates change.
- Collateral. Your home acts as collateral for the HELOC, allowing you to potentially borrow a substantial amount of money to fund your goals and dreams.
- Credit amount. The amount you can borrow from a HELOC will depend on your creditworthiness, home’s value, debt-to-income ratio, the outstanding balance of your mortgage, and your lender’s policies. Typically, lenders will let you borrow up to 85% of your home’s value (minus what you owe on the mortgage). At Lafayette Federal, our members are eligible to borrow up to 95% of their home’s value.
HELOCs versus Home Equity Loans
While both of these loan products allow you to put your home’s equity to work, they work differently and can used for different purposes.
A home equity loan, often referred to as a second mortgage, provides a lump sum payment, and often comes with a fixed interest rate. The predictable monthly payments make it easy to budget for. Repayment begins immediately after closing and the only way to access additional funds is to apply for another loan.
Home equity loans are excellent solutions for borrowers who have a specific use for the money in mind, such as a major home renovation or an upcoming medical expense. HELOCs, on the other hand, may be better suited for borrowers looking for flexibility.
How to Use HELOC to Pay Your Mortgage
Some homeowners choose to utilize HELOC funds to pay off their mortgage, thereby freeing up their monthly cash flow and potentially reducing the overall interest they pay. Essentially, borrowers would take out a HELOC, use the available line to pay off their mortgage, and then focus on making their HELOC payments.
Because of the flexibility and revolving line of credit, you could still potentially fund other expenses with your HELOC (even after paying off your mortgage).
What Is a HELOC Used For?
A great benefit of HELOCs is the flexibility they provide — borrowers can use the funds for a wide variety of expenses. Here are some beneficial ways to use a HELOC:
- Enhance Your Space (Home Improvements)
- Create a Safety Net (Emergency Fund)
- Grow Your Wealth (Investment Opportunities)
- Simplify Your Repayments (Debt Consolidation)
- Invest in Knowledge (Educational Expenses)
When used responsibly and strategically, these five uses of your HELOC can help you build your wealth and financial stability.
1. Enhance Your Space (Home Improvements)
Home improvements can bring satisfaction and improved functionality to your living space. Upgrading your interior and/or exterior not only feels and looks amazing, but can also add value to your home.
Kitchen and bathroom renovations, energy-efficient improvements, exterior remodels, and basement conversions add the most value to your home. Eliminating a bedroom and adding very personalized and unique details can actually decrease the value of your home. When considering any major renovations, think about whether they may impact your home’s value.
A HELOC’s revolving line of credit allows you to tackle each project one at a time. They can also provide you with higher loan limits and lower interest rates than typical credit cards and personal loans. And if you’re using the money from your HELOC to increase the value of your home, your payments may be tax deductible, saving you even more money.
2. Create a Safety Net (Emergency Fund)
You can never predict the unexpected. To have peace of mind, homeowners can take comfort in the fact that their home equity can give them quick access to cash when they may need it most.
If an unexpected medical bill or car troubles arise, borrowers can quickly access their line of credit and request a transfer. This can often prove to be more financially advantageous than putting an emergency expense on a credit card, as they typically charge higher interest rates.
3. Grow Your Wealth (Investment Opportunities)
Another great way to utilize a HELOC is to grow your investment portfolio. You can utilize the funds from your line of credit to purchase a second property and use it as a rental for additional income, start a business, or even invest in the financial marketplace.
Finding the capital for these types of investments can sometimes be tricky, but by using the equity in your home, you can be creative and start growing your investment portfolio in diverse ways.
4. Simplify Your Repayments (Debt Consolidation)
Managing multiple debt payments every month can be cumbersome — and costly. Homeowners can consolidate financial obligations by paying off their existing debts with HELOC funds. Depending on the interest rates of your other debts, using your HELOC can also help you save money in the long run because you can take advantage of one, reduced interest rate.
5. Invest in Knowledge (Educational Expenses)
Investing in education is a valuable way to grow your knowledge and open up new opportunities. Using the revolving line of credit from a HELOC can help pay for tuition bills when they come due. And if plans change, you’re not on the hook for a lump sum loan — you simply pay for what you use.
How to Manage Your HELOC Responsibly
While there are numerous ways to utilize the equity in your home through a HELOC, they should managed responsibly. Using these tips can help you ensure you’re taking advantage of this financial product wisely.
- Carefully assess your financial needs. It can be tempting to take out a HELOC to have access to quick cash, but before you do so, you should have a clear and concise plan for the funds and only utilize the money for essentials or financial goals.
- Have a repayment plan. The draw period is an exciting time for accomplishing your money dreams and utilizing your home’s equity. But, it is also the time to create a repayment strategy so you are prepared for the upcoming payments.
- Set up automatic payments. Missing payments can hurt your credit score and cause you to incur late fees. Ensure you never miss a payment by setting up automatic HELOC payments with your lender.
- Understand the interest rates. HELOC interest rates can fluctuate with market conditions — being mindful of your interest rate can help you plan your budget accordingly.
Secure Your HELOC with Lafayette Federal Today
Our home equity line of credit makes it easy for our members to secure the cash they need to fund their financial goals. Our team of professionals will guide you through the process, answering your questions and advising you on the best course of action for you and your finances.
We offer flexible repayment options for up to 30 years, do not charge annual fees of penalties prepayment penalties, and allow you to borrow up to 95% of your home’s value to finance a wide variety of needs.