As the debt of a homeowner’s mortgage gets paid down, and the borrower begins to own more of their home, they may begin to accrue equity.
Equity is a concept that relates directly to the difference between the home's fair market value and the outstanding balance of all liens on the property.
There is no ATM hidden in the basement of each house for the owners to directly withdraw from their equity. But there are options...
While this may sound similar to the loan-to-value ratio, equity speaks more to the specific dollar amount as opposed to just a percentage. But it’s important to remember that equity by itself is not a liquid currency. There is no ATM hidden in the basement of each house for the owners to directly withdraw from their equity. But there are options through various forms of home equity management that the homeowner may be able to unlock that monetary value that their accrued equity represents.
It should be noted that equity can go both ways. The value of a home is dependent on many external valuables including a fluctuating housing market, so it’s not impossible for a home to lose equity through no fault of the homeowner.
There are a quite a few ways for the homeowner to access the equity of their property, just a few of which are discussed here. For example, cash-out refinancing allows for the borrower to potentially extract money from their equity while they refinance their entire mortgage. A homeowner could also decide to put their house on the market as an attempt to net the accrued equity in cash.
There are also options that may be available to the homeowner that don’t require the often cumbersome task of moving or refinancing. The first option is a home equity loan.
A home equity loan consists of a one-time lump sum loan and generally includes fixed-rate interest protecting the borrower from market fluctuations during repayment. This form of equity loan could be great for some with one-time expenses like a new car or home repair.
Another potential route for the homeowner to tap their equity is through a Home Equity Line Of Credit or HELOC for short. This is an ongoing line of credit that remains open through a permitted draw period. Generally the draw period for most HELOCs is 10 years. During that draw period the home owner can draw from this fund using checks and a card that functions similarly to a credit card up to the maximum limit of the line of credit agreed upon at the outset.
The HELOC offers a few variations on repayment. The borrower could make interest-only payments during the draw period then pay interest and principal during the repayment period. The repayment period is generally 15 years but can vary depending on the agreed upon terms established by lender and borrower. Generally a HELOC comes with a variable interest rate, although some lenders do offer the potential of rolling the sum into a fixed-rate repayment plan.
While both the home equity loan and HELOC offer potentially great solutions to tap into the equity of a homeowner’s investment, it is important for each borrower to decide which option works best for their specific needs and financial situation.
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