For most people, a mortgage is the most important investment they will make in their lifetime, as it is the primary means of building personal wealth. You can also leverage your personal wealth by using the equity that accumulates in your home, as a result of paying off the mortgage, combined with the increase in home value.
WHAT IS EQUITY?
Equity is the difference between what you owe on your home’s mortgage and its value. For example, if your house is worth $300,000 and your mortgage is $100,000, you have $200,000 of equity. As you pay off your mortgage, your net worth increases. If you have big projects you want to take on, like home renovations or repairs, or you’re starting a business, you might want to consider a home equity mortgage. It has a much lower interest rate than credit cards, which carry an average interest rate of 19%.
These loans can be used not only for home repairs and renovations, but also to consolidate loans, pay off high-interest debt like credit cards, or finance college tuition. A consolidation loan combines your debts into one payment, which is a great way to handle high interest loans or those where you only manage to pay the interest and not the principal. These loans have a higher limit than credit cards, depending on the equity in your home.
There are two types of loans based on home equity. The first is a home equity loan. The other is a home equity line of credit (HELOC). Both come with a caveat: Because HELOCs and home equity loans use your home as collateral, if you can’t make monthly payments due to illness or job loss, you risk losing your home to foreclosure.
WHAT IS A HOME EQUITY LOAN?
This is when a borrower receives a lump sum in advance. The loan has fixed interest rates and fixed payments. Often they are called second mortgages.
Borrowers have predictable monthly payments for the term of the equity loan since the interest rate is fixed.
An equity loan can be repaid over a period of up to 30 years.
If you need more money for an emergency, you will need to take out another loan.
If you want to pay a lower interest rate, you will need to refinance.
WHAT IS A HELOC?
This type of loan has a variable interest rate and the payments are generally not fixed. Borrowers can tap into their equity as needed up to a predefined credit limit, make payments, and then withdraw cash.
Unlike a residential mortgage, you only have to make regular payments on the interest due on the HELOC. You don’t have to repay the principal until you sell your home. But we encourage our members to strive to repay principal so that this debt does not erode long-term net worth.
This type of loan gives you the flexibility to borrow as much or as little as you need, depending on the available equity in your home.
Monthly payments fluctuate, making budgeting difficult.
If interest rates rise – as they do – the variable interest rate may rise.
Some owners may be tempted to make impulse purchases up to the credit limit.
Speak to an advisor at North Peace Savings & Credit Union, who will help you determine the type of home equity loan best suited to your situation and needs.