The Dos And Donts Of Tapping Your Rising Home Equity
Written By: Jaymi Naciri
Tuesday, June 20, 2017
If you bought a home recently, it may already have increased in value. Equity growth goes hand-in-hand with pride of ownership and fun stuff like tax breaks when it comes to homebuyer goals, so say a big, "Yay"
"Nearly 91,000 homeowners regained equity in the first quarter of 2017, according to real estate data firm Co>But, before you go making plans for all that equity, either by doing a cash-out refinance if possible and prudent or getting a home equity loan, take a pause. That money may be best left right where it is. If you still want to tap that equity, here are some of best - and worst - ways to use it.
When your home has equity, it can be tempting to use it for home renovations, which, presumably, will further raise your home value - or at least make your home prettier or more functional. Knowing which renovations pay you back is key to making smart choices. Review Remodeling magazines Cost vs. Value Report, which "compares average cost for 29 popular remodeling projects with the value those projects retain at resale in 99 U.S. markets." You can then take your research further, viewing data for your regional area. This will help you decide if that 50,000 kitchen is a good investment, or if that attic renovation you were considering will be a bust from an ROI standpoint.
A new car
That fancy new car is calling your name, right? Does it make sense to use some of your home equity to finance or buy it outright? Ask yourself this: Is this a car you cant afford without using your home equity? Can you afford to pay the difference in your current monthly payment and what will be your new payment - plus the monthly cost of the car?
"During the housing bubble, consumers used home equity borrowing to pay for everything from boats and gambling junkets clearly bad to cars and kitchen renovations not so bad, said Interest.com. "The problems these homeowners experienced during the financial crisis and recession taught us that even some not so bad spending should be scratched from our list of acceptable uses. So, while we used to say that financing a car with a HELOC was OK, we no longer believe that. Besides,auto loansare now one of the few types of consumer loans that are cheaper than home equity loans or lines of credit."
Adding on to a home can be a great way to make it more livable, especially if the space is inadequate for your family. The Cost vs. Value Report can be useful here, too. You might be surprised to learn that a midrange bathroom addition typically only pays back an average of 53.9. But, if you bought an older home that only has one bathroom, adding another could have a much higher ROI that makes the addition worth it.
When it comes to larger undertakings, "Studies show thatnearly all of the cost of a mid-range two-story addition may be recoveredat thetime of sale," said The Spruce. "The key here is may be recovered, as there is no predicting the real estate market years in advance. While this might seem like a no-brainer, it needs to be mentioned. More space means higherheating and cooling costs, more windows to wash and gutters to clean, increasedproperty taxes, and more house to clean. Even though additions offer the potential for higher cost-value ratios than other renovation projects, you still may not recover the full cost of the addition when you actually sell."
That European cruise or trip to Machu Picchu sounds like a great idea, especially because youve got some cash to pay for it with the rising equity in your home. But consider this: You may be paying back the money you spend on that vacation long after you return home.
"The first mistake is using your home equity line of credit to live above your means," said Fidelity. "That can be paying for a vacation, using it to support going out to eat, buying luxury goods, or more generally, spending what you dont have. This risk is very similar to the risk of running up too much credit card debt, except that making this mistake with your home equity line of credit affects more than just your credit rating: It puts your home at risk."
More real estate
Leveraging one property for another is a tricky proposition. Whether youre thinking about flipping a house for the first time or already have some experience under your belt, youll want to weigh the pros and cons - and costs - involved in buying and owning two properties.
"Unlocking some of your homes value to pay for a second home has its advantages - but it has some big drawbacks too," Greg McBride, a senior financial analyst for Bankrate.com, told CNN Money. "Lenders tend to give more favorable terms to those who tap their homes equity to pay for a second home because they have more skin in the game. Buyers who take out a separate mortgage on a second home are more likely to stop making payments if they run into financial trouble and default. To offset the increased risk, banks charge higher rates and require larger down payments of these borrowers. The costs of borrowing, especially on home equity loans, can be lower as well, since these loans dont involve paying for title searches or insurance and other transactional costs of new mortgages."
Now for the negatives: "By tapping your homes equityyoull be increasing your monthly mortgage payments and increasing the risk of losing your primary home to foreclosure.
Also, by buying another home youre tying up a lot of your money into one type of asset. Youre putting a lot of eggs in the real estate basket."
With the cost of college continuing to rise and mortgage rates reaming near historic lows, homeowners are increasingly looking to their home equity to offset some of the costs of education. Heres why it may be a good idea: "With a home equity loan or a home equity line of credit, the two biggest positives are that home equity loans may be cheaper than other loans, plus the interest paid on a home equity loan is tax deductible," said HSH.com. The most important downside: Youre using your home as collateral. And then theres this: "These loans dont typically offer flexibility during periods of financial hardship," they said. "But those who borrow with federal student loans can readily obtain loan deferments, forbearance, and sometimes even loan forgiveness."
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