Fund your future with home equity

More Articles:

*How much equity do I have in my home?
*I want to renovate. What's the difference between a home equity line of credit and a cash-out refinancing?

Use your home to finance just about anything

Jeanne Lee

Jeanne Lee is a freelance business and personal finance writer living in Brooklyn with her husband and son. Her work appears in Fortune, Money and Fortune Small Business, among other publications.

Elyssa and Robert Rayner, a couple in their late 30s, are expecting twins in the fall. They want to build an addition to their house to accommodate their growing family, but they don't have enough money in the bank. They have $10,000 saved, but the project will probably cost around $20,000. Also, they know they need to have money available in case of a rainy day. Though their savings are not enough for their goals, the Rayners do have another source to finance the addition: their home.

"Millions of Americans have borrowed against the equity in their homes to fund home improvements, tuition, medical costs, and more."

Five years after they purchased it, their house is worth $230,000 and they have an outstanding balance on their mortgage of $160,000. That means their home equity — the difference between the market value of the home and the amount due to the bank — is $70,000. This home equity can be used to provide funds they can use now through a home equity loan or at any time through home equity line of credit (HELOC).

Millions of Americans have borrowed against the equity in their homes to get money for expenses like home improvements, tuition bills, or medical costs. Home equity can also be a source of funds to consolidate high-interest debt, or in case of emergency (job loss, hospital bills, etc.) Home equity loans and lines of credit have some significant advantages over other sources of funds. Because they are secured by a mortgage on your house, they carry lower interest rates than unsecured loans. Also, since these are mortgages, the interest on the loans may be tax-deductible, just like the interest on a primary mortgage. (You should always consult a financial advisor regarding the deductibility of mortgage interest.)

The proceeds from a home equity loan are usually paid out in a lump sum and carry a fixed interest rate. By contrast, a HELOC is a pre-approved amount that you can borrow against, usually by writing a check or using a credit card linked to the line; you pay interest on the amount that you use. HELOCs typically have variable interest rates, which means monthly payments could rise if rates go up.

Before you take the plunge, there are some important caveats to keep in mind. Since your house is the collateral for these loans, if you can’t repay the loan, you are taking the risk of losing it. Also, if real estate prices go down, it's possible you could wind up owing more than your house is worth. Consider carefully what you'll use the money for. Home improvement projects are a good candidate, since they can add to the resale value of your house. Consolidating debt may get you out of a short-term bind at a lower borrowing cost. But remember that mortgages have longer terms than some short-term debts such as car payments and credit cards, so you may end up paying less each month but for a longer period of time.

After some consideration, the Rayners opted to open a $50,000 HELOC. For their purposes, it's a better option than a home equity loan, since they probably won't use all that money. After their home renovation project is finished, they can keep the remainder of the HELOC on tap to act as an emergency fund.