What to Know About Using Your Home Equity
If you’re considering using your home equity but have questions about whether it’s a good fit for you, you’ve come to the right place.
Using your home equity is a great way to pay for big-ticket projects or consolidate debt. But, you may have questions and concerns about whether it’s a good fit for your current financial situation. We understand, and are here to help. Here are the factors to consider when deciding whether a home equity loan or a home equity line of credit are right for you.
We sat down with one of our home equity experts, Josh Fetting, to get answers to those very questions, and to gain a better understanding of if, and when, it might be a good idea to use your home equity.
When to consider
Before you can tap into the equity of your home, you first need to qualify. For starters, you’ll need to have at least $5,000 of equity, and a positive credit history. “At UW Credit Union, home equity loans and lines of credit are much less dependent on credit scores, and rely more on an individual’s credit history,” says Ken Carlson, Vice President of Consumer Lending. “It’s important that you’re able to make your regular loan payments on a consistent basis.” Your debt-to-income ratio, the percentage of your monthly income that’s used to pay for monthly debt payments, is also a major criterion for loan approval. Generally speaking, the lower your debt-to-income ratio, the better your chances of getting a loan.
If you do qualify, a good indicator of whether or not you should consider tapping into your home equity is your loan-to-value (LTV) ratio. Your LTV is the total amount of home equity that you aim to borrow, relative to your home’s current value. The lower your LTV, the better your interest rate, and the more protected you are from fluctuations in the housing market.
Understanding your options
When it comes to using your home equity, there are two primary options to consider: a home equity loan or a home equity line of credit (HELOC). Home equity loans come as a single, large sum of cash and often have fixed interest rates, which gives you a clear picture of how much you owe every month. “Home equity loans are great for large expenditures where you know the total cost up front, like a single home renovation project, a wedding, or consolidation of high-interest debt,” Ken says. At UW Credit Union, there are 5, 10, and 15-year options with competitively low rates.
HELOCs, on the other hand, work similarly to credit cards: they have variable interest rates, you can withdraw funds when you need them, up to your credit limit, and you only pay interest on the funds you use. “HELOCs are best used for funding intermittent needs like ongoing home projects, college tuition, or as an emergency fund,” Ken notes. Unlike home equity loans, HELOCs are split into two periods; the draw period and the repayment period. During the draw period, which typically is five years, you can withdraw funds, and pay interest only on what you take out. During the repayment period, you no longer can withdraw funds, and your payments will be higher, as they’ll include both principal and interest.
How to know if it’s right
If you’re using a home equity loan or line to consolidate high-interest credit card debt, pay for emergency medical expenses, or increase the value of your home, you can wind up coming out ahead. “If you’re planning on a big remodeling project, make sure it’s a project that’s going to increase the value of your home, and only work with reputable contractors,” Ken advises.
It’s important to remember that even though home equity loans and lines of credit offer a quick, efficient way to get large sums of money, they’re still a loan on your house. And, just like your mortgage, defaulting on a home equity loan or line of credit could result in the loss of your home.
That’s why it’s important to carefully evaluate whether you will be able to comfortably handle monthly loan payments. With a HELOC, it is wise to plan in advance for the repayment phase by understanding how much your combined principal and interest payments will be.
“If it looks like variable rates may rise and remain higher over a longer period of time, members can save convert their HELOCs into fixed-rate home equity loans, which can help them save over the long term,” Ken says. Plus, at UW Credit Union there’s low or no closing costs on HELOCs or Home Equity Loans.
If you don’t think now is the right time to leverage your home equity, you still have some viable alternatives. “If you only need a small amount of money, or if you have some credit card debt you really want to attack, personal loans or credit card balance transfers can be great options,” Ken notes. While they’ll have higher interest rates, they can still give you the flexibility to borrow what you need, when you need it.
See if it’s right for you
All in all, home equity loans and lines of credit aren’t any riskier than a traditional mortgage, and they can be a phenomenal financial tool for many homeowners. But, it’s a big decision that requires careful thought and consideration. That’s why it helps to talk to someone who puts you and your financial well-being first. Get in touch with one of our home equity experts, and we’ll work together to determine if using your home equity is the right move for you.