What is Home Equity and How Can You Make it Work For You?

Kate Robinson
Greater Nevada Credit Union

The goal of this blog is to provide information that will help you Live Greater financially. Sometimes banks and credit unions take it for granted that consumers understand all of their financial lingo, but I know from personal experience that’s not always true. So this week I am going to address a question some of you may have about a commonly used term: home equity.

What is home equity?

Put simply, home equity means the value of your home beyond what you owe on it. So if you still owe $150,000 on your mortgage, but your home is worth $200,000, you have $50,000 in equity. A home equity line of credit is a product offered by financial institutions to help you use that equity to your advantage.

How do I know if I have equity in my home?

According to Greater Nevada’s Vice President of Lending, Marcus Wertz, many people are surprised to find that they do have equity in their homes. A simple way to find out is to just call a mortgage consultant, who will use the Automated Valuation Model (AVM) in lieu of a full appraisal to give you a starting point, based on your neighborhood. Typically the AVM is much less expensive than an appraisal – usually about $20. However, if you have a custom home in a neighborhood where custom homes aren’t common, or other unique circumstances, you may want to get a full appraisal to find out just how much your home is worth. If your mortgage is paid off entirely, you know you have equity to work with.

Okay so I have equity. Now what?

Greater Nevada will lend up to 80% of the loan-to-value ratio, including your first mortgage and the line of credit. In other words, if you owe $150,000, but your home is worth $200,000, 80% of your LTV would be $160,000. Since you already owe $150,000, you could get a $10,000 HELOC. The rate of a HELOC is variable, since it is based off the prime rate plus a margin.

Why would I get a HELOC?

The nice thing about a line of credit, is that you don’t have to use it. Marcus told me that many people use their HELOC simply as an emergency fund. It’s like having a $10,000 (using the example above) credit card, but usually with a much lower rate, and it can be tax deductible*. You only pay what you owe on it, so if you have no emergencies you could have that line of credit open for ten years without paying a dime. If you do owe on it, the minimum payment is an interest-only payment (during the draw period, which is usually ten years), but you can opt to pay extra and apply it to the principal. After the draw period is over, you begin repaying the outstanding balance, but can no longer access the funds. At this point you have the option of simply continuing to pay the HELOC off, or refinancing to start your draw period over.

Other good uses for HELOCs include debt consolidation – combining all your high-interest debts into one loan with one payment and one low interest rate – and renovating your home. The bonus to using the HELOC for renovations is that you’re using the value in your home to actually increase the value in your home.

What should I not use a HELOC for?

Technically you can use a HELOC for whatever you want, but some options (like those listed above) are more responsible than others. Marcus recommends that you don’t use your HELOC for purchases such as vacations or new cars. If you need a new vehicle, an auto loan is going to serve you much better than a HELOC would. Personal loans or lines of credit would be better options to fund your vacation, as they won’t take nearly so long to pay off, and your vacation won’t provide added value over a long period of time. Basically a HELOC should be thought of as an investment to fund something of lasting value, or to be used as an emergency fund. Marcus also warned against using the HELOC for debt consolidation if you’re going to keep your using your credit cards after you pay them off. Make your debt consolidation plan work for you by discontinuing use of those cards as soon as you’ve used the HELOC funds to pay the balances off.

Also, if you own your home outright and don’t want your property to have a lien-holder, a HELOC may not be the right plan for you. It is a mortgage loan, so the lender does place a lien on the property until the loan is paid.

Do I qualify for a HELOC?

The qualifications for a HELOC are very similar to other types of loans – involving credit score, debt-to-income ratios, and more. The Greater Nevada HELOC includes a $75 annual fee, waived for the first year, but it costs nothing to originate the loan, unless you have to get an appraisal which is paid for up front. However, if you pay it off within two years, you will have to pay an early payment penalty. That’s just how financial institutions recoup their costs associated with the loan.

Hopefully this helps clear up any questions you might have about the product, but of course we’d love to hear from you if you have any more.

*Consult your tax advisor for possible tax benefits.

05/23/2014