There are several benefits to home loans, such as making it easy and affordable to buy a home even when the market isn't great. But there are risks involving property investment, and one of them is equity loans.
Home loans have always been thought to appear riskier when equity is involved. The classic scenario is raising home prices while making more loans available. But there is a way to use equity loans to your advantage.
If you do it the right way, using equity loans for property investment isn't so risky. If you do it the wrong way, the stakes are high.
There is a right and a wrong way when using equity loans. Here are ways to use equity loans where you will win in the end.
Two Types of Home Equity Loans
When using equity, there are two main types of home equity loans:
1. Home Equity Line of Credit (HELOC) - this is a revolving line of credit and acts very similarly to a normal credit card. You only pay off what you spend; spending examples include renovations and repair.
2. Home Equity Loan - this is similar to a traditional loan, meaning you're borrowing a certain amount and make fixed monthly payments. You especially benefit from a home equity loan if you already have equity in your home.
In short, equity is how much of your home you own.
Know Which Type of Home Equity Loan You Need
A good fact to keep in mind when using equity is a home equity loan requires a large sum of cash to be put down.
For example, most banks require a minimum of $10,000 up front.
Can't afford that? Or prefer spending less?
You can opt for a HELOC. You won't be able to build equity as easily since it takes longer to actually pay off the cost of the home. You will also have to commit to a long-term investment.
But you only borrow what you need, you don't get a fixed rate, and interest rates are adjustable.
Pay More on the Monthly Payment
One of the benefits of taking a home equity line of credit is the convenience of not having a fixed monthly payment. However, paying less causes your interest rates to increase.
The best practice of using home equity line of credit correctly is paying a larger payment each month to pay off the loan and reduce your risk of interest increase.
Build Up Equity
If you plan on owning a home, it's best to start building equity. You can either factor in using equity that you have when you first purchase your home or the equity you're building over time.
There's a major benefit when focusing on building equity: selling your home.
Let's say you decide to sell your home when your loan is paid off. If you paid $300,000 for your home, this is the amount you're entitled to.
But let's say the market price of your home was $300,000 and you only paid $80,000. You're only entitled to $80,000.
Build Equity by Market Value
Paying off your loan isn't the only way when using equity. There are factors outside of your control, such as the housing market. But you can control renovations that could increase property value.
Your best bet is when housing prices rise on its own, based on the market. Therefore, you're building equity by essentially doing nothing.
But, this is only a situational occurrence. If you truly want to make the best out of building equity, increase value in your home by upgrading your home and making it more modern and increase curb appeal.
Agree on a Shorter-Term Home Equity Loan
If you're unsure about using equity, your best bet is to take a shorter term loan. This way, you build equity faster and decrease your chances of being in debt.
Another added benefit of shorter-term mortgages are lower interest rates, so you pay off your loan much faster.
When taking a mortgage, expect the duration to be longer. But try and stay within the 10-15 year range, and try to not take a loan lasting longer than 20 years.
When taking a shorter term loan, you become closer to building equity on your home.
There's nothing wrong with paying extra on your home equity loan. While you will be required to pay a minimum payment, there is nothing stopping you from paying, even more, each month.
The principal when building equity is coming closer to fully owning your home in a financial sense.
Let's say later down the line, you can't financially afford to make higher payments.
You already built enough equity to where you can change your loan, reducing the interest and the monthly payments. Or, pay extra every other month or pay little more each month.
If you truly want to build equity and reduce debt, don't refinance or sign another mortgage. When you take either action, you decrease your equity and are more vulnerable to being in debt.
Each time you refinance or sign another mortgage, you're reversing the process of paying off your home and decreasing interest.
The best way to increase your home's equity and reduce debt is to keep paying off your loan, which increases equity and reduces interest.
Benefits of Building Equity
Most like to think of equity as a savings account or extra cash. But rather than that cash being stored in a separate account, that cash is stored in your home.
When you build equity, that money is yours. You can use that equity to sell or home or trade-in that equity for physical cash, which you can use however you like.
Or, you can use that equity to buy a new home. This reduces the need to take out a loan. In addition, you can take out another home equity loan to start building equity in your new home, which can give you even more money.
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Now It's Time to Start Using Equity Right
Whether you decide on the home equity loan or HELOC, it's key for all homeowners to start building equity. When you build equity, you decrease your interest rates and decrease your chance of being in debt.
You can also exchange that equity for cash or even use it to buy a new home.
If you're looking to invest in a home, let us guide you through your property investment goals.