Ten Things to Consider Before Tapping into Your Home Equity

The equity you’ve built since buying your home can be a useful financial resource. However, considering these ten key factors is crucial when exploring if and how you want to tap into your home equity

Ten key factors to consider:

Purpose

First, you want to determine the specific reason or reasons that have you considering a home equity loan or home equity line of credit (HELOC). A renovation? Educational expenses? Debt consolidation? Whatever the purpose, understanding how a home equity loan or HELOC will strengthen your financial position or impact your long-term financial goals will help you determine whether utilizing your home equity and with which approach is right for you.

Terms

Once you have your ‘why’ determined, ponder the ‘how.’ Does a lump sum payment or a line of credit to draw from make more sense for you? How long will you need access to funds?

Rates

Determine whether a fixed or variable interest rate is a better fit for your situation. For instance, home equity loans typically have fixed interest rates and fixed monthly payments over the loan term. HELOCS, on the other hand, are variable, meaning they can fluctuate over time based on market conditions. During the draw period, borrowers can make interest-only payments or choose to pay both the principal and interest. After the draw period ends, a repayment period begins, during which the borrower can no longer access funds and must repay the outstanding balance over a fixed term.

Value

During the application process, a bank lender arranges to have your home appraised to supply an appraisal report that will help determine your loan-to-value (LTV) ratio (see the ‘Assessing the Total’ section below). To get a general sense of your home’s valuation, examine comparable homes in your neighborhood.

Equity

Knowing your equity position is important as lenders will allow borrowing up to a percentage of your home’s value minus your mortgage balance. The borrowing limit will depend on the amount of equity you currently have in your home. Typically, to qualify for a home equity loan or HELOC, lenders require that you have 15%-20% equity in your home.

Outstanding Balances

Additional expenses that will also be subtracted from your home’s value to determine the equity available include existing home equity loans, HELOCs, and liens.

Assessing the Total

So how much money will you be able to borrow? Let’s assume that you have good credit, steady income, a positive payment history, and a low debt-to-income ratio (percentage of your monthly income that goes to monthly obligations). For the purposes of a general example, let’s say you’ve estimated that your home is valued at $500,000 in the current market and you still owe $300,000 on your mortgage.

In this scenario, your home equity would be $200,000. Your LTV ratio measures the amount of a loan compared to the appraised value of the property. So, if your home is valued at $500,000 and you owe $300,000 on your mortgage, your LTV ratio would be 60%, which means you have 40% equity in the home. Now let’s say your lender’s loan-to-value limit is the standard 85% of your home’s value. We arrive at $425,000. Don’t forget the $300,000 you owe on your mortgage! That will be subtracted from your estimate, so your estimated borrowing limit would be $125,000.

Size

Now, how much equity should you actually use? This is a question best answered by considering your ‘why’ again. What is the exact amount needed for the purpose you determined earlier in the article? Equity can take a long time to build and borrowing a reasonable amount without jumping to borrow the maximum allowable figure may be a wise choice when possible.

Budget

Borrowing against your home means adding a new financial obligation to your life. How would your estimated monthly payment fit into your current budget? Using home equity responsibly means planning for both steady times and when things are otherwise. Comfortably being able to accommodate the payment into your budget over the long term is advisable.

Risk

Remember that tapping into your home equity is using your home as collateral. What would happen if your income changed? Would you still be able to make the payments? If you’re spending more money than you make, for example, then adding a new loan repayment may not be the right step to take, as it could put your credit rating and your actual home at risk.

Putting It All Together

Consider your long-term financial goals by examining your present situation. How would a home equity loan or HELOC fit in with your mortgage, other debts, and your savings? If it leaves you with little “wiggle room,” reconsider the amount you’re borrowing or whether now is the right time to enter into a new loan agreement. Your home represents years of commitment and using it as collateral should be approached carefully. Review this list and the overall financial objectives when deciding if a home equity loan or HELOC aligns with your specific needs and goals.

At Norway Savings Bank, we want to simplify the borrowing process. Our local lending experts meet you where you are, take time to understand your needs and when we’ve found the right option, make the application process fast and easy. Ready to get started? Check out our Home Equity page, or contact a lender.

This article was written by NSB residential lending experts, not generated from artificial intelligence.