A home equity loan has many uses. It is up to the homeowner to decide just what to do with the money. The portion of your home that you “own” is called the equity. You can figure it out based on the current value of your home and the outstanding principal balance of your mortgage. The difference between the two is your equity. Because that money is not liquid; it remains in your home, you need to take out a home equity mortgage in order to tap into the equity. But just how can you use it? There are many different ways.
Many people take out a home equity line of credit, which is a form of a home equity loan. This line of credit is like a bank account into your home equity. You have to qualify for the mortgage based on your credit, income, debt ratio, assets and the value of your home. Once the lender approves you and you close on the loan, the lender provides you with access to the funds, which are usually up to 80% or so of the full value of your home. Most lenders provide a checking account with checks or a debit card that you can use to access the funds.
If you take out the line of credit strictly to have an emergency fund, you can let the funds sit there untouched. You do not make any payments on the money unless you withdraw it. If you take money out with a check or the debit card, you then pay interest on those funds. Typically, this lasts for the first ten years of the loan, called the draw period. Once the draw period is over, you no longer have access to the funds and you must then pay the principal plus the interest back to the lender. It is nice to have that emergency fund available should something unexpected come up with your home or even your personal life.
If you have large amounts of debt hanging over your head and you do not like paying multiple creditors every month, you can use the home equity loan to consolidate the debts. In this case, the lender will not give you access to the funds, but rather pay off your other creditors. You decide with the lender how much of your debt you can afford to include in the home equity mortgage. This will play a factor in your ability to obtain approval as well since it affects your debt ratio. Obviously, the more debts you pay off, the lower your debt ratio becomes, but you also have to figure in the new mortgage payment to determine if your debt ratio fits the mold.
If you end up paying off all of your monthly debts, you just make the one payment to your new home equity lender. The remaining debts get paid off at the closing with the proceeds of the loan. If you are financially responsible, you will keep those revolving debts at a zero balance and focus on paying down the home equity mortgage to fully get out of debt.
Make Changes to your Home
Perhaps the most common use for a home equity loan is to make home improvements. This could mean many things – you could make necessary repairs, such as replacing a roof or an HVAC system; you could make cosmetic changes that you desire or make major renovations including room additions. The changes you make obviously depend on the amount of equity you have in the home and how much you qualify to receive. Because repairs and or renovations to a home can greatly increase its value, this is often considered the most valuable use of a home equity mortgage as it gives you a return on your investment.
Pay for College
Student loans are expensive and there is no way around it! If you have equity in your home, though, you can tap into that money to pay the costly tuition and room and board. Sometimes it makes more sense for borrowers to tap into the equity of their home than take out the costly student loans. If your household makes too much money to receive any type of financial support from the government, this is usually the best option. Because you get a tax write-off for a portion of the interest you pay on the home equity loan, it can be beneficial for you to go this route rather than taking out traditional student loans.
Starting a New Business
Starting any type of business can be rather costly, making it difficult to get ahead. A home equity loan can help you gain the capital you need to start the process, though. The good news is that with a business, you usually make the money back faster than you would with any other method. This means that you could get the home equity loan paid off faster than you would if you took the money out for another reason, such as debt consolidation or home improvements. As your business takes off, you can have the capital you need to keep going while still paying your mortgage down or off.
How you use a home equity loan is really a personal choice. Most lenders do not question how you will use it unless there are special circumstances to your loan. If you have a good reason, though, such as consolidating debt, it could help you qualify for the loan, especially if you have a high debt ratio. In general, though, you can take out the home equity mortgage in the form of a line of credit and use the funds as you see fit.