How to Make Your Home Equity Work for You

If you own your home, you could be sitting on a gold mine. You’re probably thinking that that can’t be true. In this market? With our crazy economy? Yes and yes. And if you have a gold mine, why not use some of the gold in order to make even more? Here’s how you do it.

The first step in putting your home to work for you is understanding what home equity is. Home equity is the value of your home ownership that accrues as you begin to pay down your mortgage while the market value of your home goes up.

Here’s an example. Let’s say you bought your home several years ago for $100,000. You’ve been making your mortgage payments faithfully and now only owe $80,000 on your home. While you’ve been making those payments, the value of your home has increased to $110,000. In simple math terms, your home equity is the current market value minus what you have left to pay off the mortgage. In our example, the current market value is $110,000 and the remaining mortgage debt is $80,000, so my home equity is $30,000.

Simple, right? You can use one of these tools – or try several of them to compare – in order to get a good idea of what the current market value of your home is.

One of the top reasons that people choose not to invest in real estate is that they think they don’t have enough money to do it. Now that you have determined the amount of equity you have in your home, you can start to put it to work for you.

Your next step is to familiarize yourself with the ways that you can borrow against your own home so that you can determine which method is best for you.

A Home Equity Line of Credit (HELOC) functions similarly to a credit card. You are allowed to borrow up to a certain amount of money, but you’re not getting all of that money at one time. Instead, you withdraw it as you need it and pay it back as you can. For instance, let’s say you were approved for a HELOC of $10,000 and you immediately use $4,000 of it to do some repairs on your home. Then you stop taking money from it because your immediate need is resolved, and you work to pay back $2,000 on the principal. That would mean you now have $8,000 on your HELOC available for you to use for additional needs.

The interest rate for the HELOC varies and fluctuates over the course of the loan. You’re also only paying interest on the amount that you borrow, not the full amount of the line of credit. Going back to our example, that would mean that you would only be paying interest on the $4,000 taken from the $10,000. You must pay back the amount you have used in full by the time that the life of the loan expires. You can find a good basic primer on the HELOC here.

A HELOC is different from a Home Equity Loan because you can keep using the HELOC indefinitely (or for a set period of time that you determine with your lender), whereas a loan gives you all of the money you are approved for upfront, and then expects you to pay it all back without re-borrowing against it. In our $10,000 example, you would get all of the $10,000 upon approval from the loan whether you needed it or not, and then you would need to start paying back the loan immediately.

A cash-out refinancing has to do with your existing mortgage loan(s). It allows you to borrow enough money to pay back an existing mortgage loan and then also take out additional equity as a one-time cash payment. The result is a loan that functions much like a mortgage in that it’s fixed-rate and typically extends for a longer period of time, like 15 or 20 years.

The answer largely depends on what you need the money for that you are borrowing. If, for example, you need to purchase a new water heater for your home, which is a fixed, one-time cost and the only thing you need money for, a loan might be the best option for you. However, if you are in need of a flexible amount of money that you can continue to borrow from and payback over a period of time, then the HELOC is best for you. If you need a large sum of money upfront, know that you are going to be in your home for a while, and can secure a lower interest rate on a mortgage than what you’re currently paying, than a cash-out refinance might work for you.

There are several pros and several cons to consider when you qualify for a HELOC.

PROS

• The funds are there to borrow as you need them, which allows them to be used on an ongoing basis, borrowing and re-borrowing money as you need it for the length of time that the line of credit is open.
• The rate of interest varies, but some lenders may allow you to convert to a fixed rate of interest or a fixed-rate loan if you can secure a great rate that you’re happy with and you know you won’t need any more access to the money.
• Even if you keep the varied rate, it is likely still lower than other forms of borrowing.
• The interest on your HELOC may be tax-deductible. (Check with your account/CPA.)

CONS

• While the variable interest rate can definitely be a pro, it can also be a con. Variable interest rates are tied to the prime rate, and you could end up owing a higher balance than you planned depending on how the market is going.
• You may have to have a timeframe built into your HELOC terms that determines how long you have until you need to start withdrawing the funds. You will have a set end date, and your balance is due in full at that point or you risk significant penalties.
• It will likely cost you some money in order to secure the documents you need to qualify for a HELOC. (See the following sections for more on what you need to have in order to qualify for a HELOC and the supporting documentation that is required.)
• Because you have access to all of this money whenever you want it, you must make sure you’re disciplined enough not to wastefully spend it, but rather use it for whatever it was that you obtained the HELOC for in the first place.

Lenders will examine several things in order to determine if you qualify for a HELOC. As a starting point, you can use this mortgage calculator to see how much you would qualify for in a HELOC based on what you currently owe on your home and how much equity you currently have.

• Good credit – Having less-than-stellar credit doesn’t necessarily mean that you won’t qualify, but it does mean that your interest rate will likely be higher. The better the credit score, the better the rates and the bigger the loan could be.
• Enough equity in your home to borrow against – Lenders generally agree that you should still have 10-20% equity in your home remaining after you have borrowed the money. So for example, if your home is worth $100,000 and you still owe $70,000, you have 30% equity. If the lender requires that you keep 10% of the equity ($10,000 in our example), then you would be able to borrow 20% or $20,000.
• A good debt-to-income ratio – The less debt you currently have, and the more you’re currently paying on those debts, the better your position for acquiring a HELOC at a good rate.

Because both are based on the value of your home, you need similar documents whether you are applying for a HELOC or the loan. Every lender is different, so please consult your lender prior to compiling and submitting your documentation. However, basic documents that borrowers are usually asked to provide with regards to your property are a copy of your homeowner’s insurance policy, a copy of your property tax statement, a copy of your current mortgage statement, and a copy of your association fee statement, if applicable.

You will also need to provide documentation regarding your income and current employment. These documents likely include the following: recent pay stub(s), recent W-2s and 1099s, verification of employment for a couple of years, current statement from any retirement accounts, and two years of personal income tax returns. Additionally, if you have a rental property, you will need to provide details on the rental income you get from that, including a current lease agreement.

Again, you may not need all of these documents when you apply for a HELOC or a Home Equity Loan. On the other hand, you may need all of this and more. Please check with your lender for an exact list of documentation needed to secure your HELOC or HEL.

In my own real estate investing journey, I have successfully obtained and used two different HELOCs with the goal of purchasing more investment property. I chose HELOCs over HELs or cash-out refinancing because I knew that I would need money for the down payment and potentially for repairs or upgrades to the property before I rented it out. So I needed to have flexible access to my money.

The first HELOC I got was through the San Diego County Credit Union. It took about three months for me to go through the approval process and in the end I received a HELOC for $100,000. I used that money to purchase my first rental property in cash.

The second HELOC I got was through Mission Federal Credit Union. They required that I close the first line of credit that I had before taking out the new one with them. I did this by refinancing my mortgage and my HELOC into one loan. Then I was able to get my second HELOC, which I also used to make a down payment on a different rental properties.

What I liked as an investor with regards to the HELOC is that there were no fees involved in withdrawing the money. Under the terms of my HELOC, the money was there when I needed to take it, or I could leave it alone if I wasn’t ready to use it.

Now I have two rental properties that bring me a significant return on the investment that I made in them. Had I not used the equity that I built up in my own home to obtain the HELOCs, that equity would still be sitting there not doing anything to help me earn additional income. Now my home equity is working for me and it’s generating a significant amount of additional income for my family each month, allowing my wife and I to work less and be home with our kids more, which was our personal goal.