We’ve all heard the saying: “Real estate is an investment.” Rather than throwing money away on rent, homeowners are able to pay down the cost of their houses through mortgages, which go directly into the property’s ownership. Similarly, real estate assets usually increase in value over time, allowing investors and homeowners to make money on strategically-purchased properties. Few people, however, understand how they can use their current homes to purchase second homes. As with most investments, real estate allows homeowners to utilize lines of credit. In refinancing your home, you can fund children’s educations, other large-scale investments, and second homes. Home equity, as realized through a refinanced home, is one of the best ways to expand your investment.
In simple terms, home equity is the market value of a homeowner’s unencumbered property interest. This number is the difference between the home’s fair market value, as determined by an appraisal, and the outstanding balance of all liens on the property. Equity increases as the debtor, the homeowner, makes payments toward the mortgage balance. Equity will also increase as the property value appreciates. Homeowners may acquire equity from their down payment and the principal portion of any payments made against the mortgage, as well as from property value increases. This line of credit is often used as collateral for a home equity loan or home equity line of credit, also known as HELOC. This financing is provided by a lender who agrees to provide credit using the home itself as insurance.
Home Equity Lines of Credit
HELOC is an excellent financial tool. Homeowners can receive a line of credit for up to 90% of the appraised value with no closing costs. The appraisal itself is often the only out-of-pocket cost, and no reserves are necessary. The best pricing is awarded to those with credit scores over 740, but HELOC is available to most individuals with credit scores over 700. The interest rate is often significantly lower than most loans, starting at 3.75% for the first six months and dropping to the prime rate for the remaining repayment period. Users can submit interest-only payments for the first ten years, after which they will pay the principal plus interest for the last twenty years. The HELOC must remain open for three years, but the balance can remain $0 if you have utilized all funds.
Utilizing home equity or HELOC can be a scary experience for homeowners. In most cases, a home is a consumer’s most valuable asset, and failure to repay a HELOC or home equity loans can result in foreclosure. In fact, HELOC abuse is often cited as a major cause of the subprime mortgage crisis in 2007. However, the money available through this type of refinancing is generous, and lenders are often more willing to provide these funds than other types of loans—using a home as collateral is meant to guarantee prompt repayment. If you are looking for ways to finance the purchase of a second home—or, perhaps, a remodel, education, or large medical bills—HELOC and home equity loans should be carefully and strategically considered.