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Wondering if you can or should borrow against your home equity? And, if yes, how soon can you pull equity out of your home? This blog will explore some crucial factors to consider if you’re thinking of tapping into your home equity for a loan.
For the uninitiated, home equity is the difference between your house’s market value and the loan balance you owe against it. Simply put, it’s your home value minus your mortgage balance. This value can get you access to the best loans out there. You can utilize financial products such as home equity loans, home equity line of credit (HELOC), or a cash-out refinance.
Having said that, while your home is a significant financial asset it may not always be a good decision to tap into your equity for funds.
If you’re planning a major home renovation or a significant expense, you’ll need to consider how much money you’ll be able to borrow, how soon can you pull equity out of your home, and most importantly if you actually should tap into your home equity for your financial situation.
How to calculate home equity?
Your home equity is the actual home value you have – the appraised value minus the money you still owe on your mortgage loan. For example, if your home’s market value is $200,000 and you owe $120,000 in mortgage balance, the equity in your home is $80,000.
The maximum most mortgage lenders allow you to borrow against your equity is 80 percent to 85 percent. So, if the market value of your home has gone up or you’ve paid down a good amount of your mortgage balance, tapping your home equity for a new loan may make good financial sense for you.
If you’re applying for a home equity loan, your loan-to-value (LTV) ratio can be calculated by dividing your mortgage balance by your home’s appraised value. So, if your mortgage balance is $120,000 and your home’s market value is $200,000, your LTV would be 60 percent. Which would mean that you have 40 percent equity in your home.
How and when can I take equity out of my house?
You can utilize the equity in your home in a number of ways. Keep in mind that your best home equity loan option depends on what you’ll be utilizing the lump sum or credit line for.
Home equity line of credit (HELOC)
This second mortgage comes with a revolving balance, almost like a credit card. The interest rate generally varies with the prime rate – unless it’s a fixed-rate HELOC.
During the draw period of 10 years, the line of credit is open and the borrower makes interest-only payments. The subsequent repayment period of 20 years includes the principal repayments.
Home equity loan
This second mortgage comes with a fixed loan amount, at a fixed interest rate, to be repaid over a pre-determined loan term. Typically, its interest rate is slightly higher than a first mortgage.
This loan type allows you to refinance your current mortgage or replace your existing mortgage for a better rate – allowing you to pocket the difference in cash.
How soon can you pull equity out of your home?
Technically you can apply for a home equity loan, HELOC, or cash-out refinance the moment you buy a home.
However, you won’t have much equity to draw from.
The answer to “when can I take equity out of my home” depends on your mortgage terms, monthly mortgage payments, and the real estate market.
Generally, an average home appreciates 4% each year – adding to your home equity. Of course, the increase in value will depend to a large extent on the housing market.
For example, due to the booming real estate market, the year 2021 saw an average increase in home value by 14%.
Your mortgage payment schedule too affects your equity. The longer the loan payment term, the slower the rate of equity building.
Should I tap into home equity, or not?
Tapping into your home equity is not as simple as withdrawing money from a bank account. If you default on your mortgage bills or loan repayments, you could lose your home – your most prized financial asset. Before you tap into the equity in your home for funds, do weigh the pros and cons.
Pros of taking equity out of your house
- You can access huge amounts of cash at lower interest rates than a personal loan or a credit card.
- Ideal loan option for covering expensive home renovations, college tuition fees, or debt consolidation.
- Offers greater flexibility due to multiple terms and repayment options.
- Often, the interest paid on a home equity loan or line of credit for home improvements might be tax-deductible.
Cons of taking equity out of your house
- It involves risking your home that’s used as collateral for the mortgage or equity product.
- A foreclosure could bring down your credit score. And, tarnish your credit report for seven years, starting from the date of your missed mortgage payment. Subsequent loan qualification and loan approvals are also difficult.
- If your home value declines, you run the risk of owing more than what your home is worth.
Ways to increase your home equity
If you’re looking to borrow funds against your home but don’t have enough equity, you could find ways to increase the amount of equity you have.
Pay off your mortgage faster
If there’s no prepayment penalty, you could try to pay off your remaining mortgage in full or make larger or extra monthly payments to your mortgage principal. This will also help you save thousands of dollars in interest.
Increase your property value
Increasing your home’s value is another way to build home equity. You could plan a home remodeling that yields a good return on investment (ROI) such as roof replacement, kitchen renovation, or room addition, yard landscaping, solar panel installation, or make your home energy-efficient or smart through the latest technology.
Keep in mind that not every renovation will increase the value of your home. That’s why it’s important to do your research before any major home improvement project.
Refinance to a shorter loan term
You could consider refinancing to a shorter-term loan – provided you can comfortably afford to make higher monthly mortgage payments and the closing costs. For example, switching to a 15-year mortgage from a 30-year mortgage will help you pay off your mortgage loan sooner while building home equity. And, you’ll pay less interest overall.
Improve your credit score
A good credit score won’t necessarily boost your home’s equity, but it would get you access to some of the best loans and favorable interest rates. That’s because mortgage lenders consider borrowers with bad credit scores as high-risk while they view homeowners with good credit as more likely to be able to repay a loan. To improve your credit score, you’ll need to pay all your bills on time and keep your credit card debt low.
Take advantage of market fluctuations
It’s a good idea to regularly monitor and check the value of your home based on the market conditions such as increased housing demand. As the demand grows, the home prices will increase – so will the value of your home and its equity.
When not to take equity out of your house
Now that you know the answer to “how soon can I take equity out of my house”, you need to know when not to tap into your home equity.
- For unnecessary, impractical, frivolous items such as big-ticket purchases. Apply for a home equity loan only if you’re planning to pay for a large-scale renovation, medical bills, or your child’s education.
- If you’re planning to move and sell the house in the next couple of years. You may have to pay off the loan balance with your house sale price.
- If you don’t have any emergency savings. Keep your home equity as a backup plan for any financial emergency, medical crisis, or accident. This is really important if you do not have substantial savings.
- You’re struggling financially to make your mortgage payments. You’ll not want another loan and its monthly payments on your statement.
- You have a below-average credit score. You may be able to procure a home equity loan with a bad credit score but your interest rates will be high.
If you answer yes to any of the above conditions, it’s best to consult with a financial advisor before applying for a home equity loan.
When is the right time to pull equity out of your home?
You may consider tapping into your home equity in certain situations.
- If you’re renovating your home and adding value to it. You will be able to recoup some of that money back in return.
- You have an excellent credit score. It can get you the lowest interest rates from most lenders.
- You have good home equity built up. If you need money to fund a large expense, you can either sell your home for a profit or apply for a home equity loan.
More than how soon can you pull equity out of your home, it’s about why should you take a loan against your home. Whenever you’re making a huge financial decision, it’s always best to do your research thoroughly. Make sure you know exactly what you’re getting into.
- Your home equity is when you subtract the amount you owe on the mortgage from your property’s current market value.
- If you’re planning to pull equity out of your home, your options include home equity loans, HELOC, and cash-out refinancing.
- Tapping into your home equity gives you access to funds without compelling you to sell your home. Or, take out a personal loan that comes with a higher interest rate.
- The maximum borrowing limit against your home is usually 80 percent to 85 percent of your home equity.
- It’s a good idea to build as much equity in your home as possible as a line of defense against a financial emergency.
- How soon can you pull equity out of your home depends on your mortgage, payment schedule, the amount of equity in your home, and your overall financial situation.