Accessing the Value in your Home (08/15/2016)

For many people, your largest asset is your home. While it is important to remember that while you are living in your home, this asset serves as a home first and not a bank account; you can, however, access the value of your home in the form of a home equity loan or a line of credit.

The combined loan to value ratio (CLTV) is the amount you owe on outstanding home loans, divided by the market value of your home. If that ratio is high, lenders will hesitate to let you borrow against the home’s value. Typical CLTVs these days run in the 70-80% range.

An example: Your home is worth $300,000. You owe $150,000. If you divide 150,000 by 300,000 you get .50. You have a 50% loan to value ratio. A lender that allows a CLTV of 80% would grant you a 30% home equity loan or line of credit, for $90,000. The two options are different.

A home equity loan is a lump sum, one-time equity draw. This is commonly referred to as a second mortgage. Usually structured with a fixed interest rate, a home equity loan is a good source of funds for major projects and one-time expenses. With a fixed interest rate, you can budget for the monthly payment, and the interest you pay is often tax deductible. The downside to this option would be if property values decline in your area while you have the loan.

A home equity line of credit, called a HELOC, allows you to draw funds as you need them. The credit can be accessed with a debit card or by writing checks. This is a convenient way to pay for ongoing projects or for multiple cash needs. You’ll pay interest only on the amount you draw. HELOCs may have a lower interest rate initially, but feature variable rates, which rise or fall according to the movements of an interest rate benchmark. This means your monthly payment can rise or fall, too. You may have flexibility to make just interest payments but you will have to eventually pay the balance when the negotiated term ends. Again, interest is usually tax deductible.

Terms and characteristics of home equity loans and lines of credit vary from one lender to another. Make sure you understand the repayment terms of your loan or line before you commit to a lender. The equity in your home before selling can be a powerful financial benefit, but remember that you are using your home as collateral. Tapping the equity in your home for home improvement, college funding, safety funds, or supplemental retirement costs make sense, but be disciplined with use for short-term needs.

Lisa Dugan

August 15, 2016