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Equity is the difference between your home's fair market value and the outstanding balance of what you owe on your home. A simple example is when your home is worth $200, 000 and you owe $150,00, then you have $50,000 in equity.
It is easy to figure out what you owe on your home, but it is more difficult to know what your home is worth because it fluctuates, especially in different areas across your state and country. Before a bank issues you an equity line of credit, or home equity loan, they will have an assessment done of your home to know its value and therefore determine your amount of equity.
What are the do's and don'ts of using your equity?
Don't borrow more money than what your home is worth. Dave Ramsey said, "A home equity loan is where you borrow money against your home. If you get a home equity loan, you are risking the roof over your family. This is your home, your shelter! It is stupid to borrow more than your home is worth! You're just asking for Murphy to move in!" Do not think that using your equity is your quick fix to getting out of debt.
Do use your equity to improve your home. If you decide to build an addition to your home or add improvements then this will add value to your home, and it would be wise to use your existing equity to do this. Don't use your equity for big purchases that are simply luxuries - the big boat, new car and furniture; exotic vacations, expensive toys and so forth. Save for these items. Do not risk your home and your family's security on impulsive buying.
Do use your equity for emergency events. If you do not have a savings to cover emergency events, then your home's equity can provide a relief when things happen, but an emergency savings should be your first goal. How much do you need in an emergency savings? The Wall Street Journal‘sComplete Personal Finance Guidebook says: "How much is enough? The answer is different for different people in different situations. For those in careers with a large, ongoing demand or who have relatively strong job security, three months' worth of expenses is probably enough of a cushion."
Don't use your equity if you are moving soon. If you want to sell your home, then all debts toward the home have to be paid off. It would be a bad decision if you tap into your equity and are not able to pay the loan or line of credit before you want to sell your home.
Do invest your equity money if you do not need it for a safety net. Education for your children falls into an investment. Other ideas could be financing a strong business idea or other moves that are sound in providing a better return on your money. But only do this if you can afford to use your equity and not lose the roof over your head. Home equity loans and lines of credit can simply be good or bad. It's all about how you use them.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice.
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