Homeowners, like many people throughout the country, are feeling the economic effects of the pandemic. Handling family and debt expenses in the face of unemployment or declining income can be a major challenge. The good news is that homeowners may have an untapped resource in plain view. The Wall Street Journal found that American homeowners hold $10 trillion in home equity, thanks to years of home value appreciation.
If balancing financial obligations is straining cash resources, some homeowners find that tapping into their home equity is a viable solution. So, is now the time for you to consider a new home financing agreement, such as tapping into your home equity?
What Is Home Equity?
Home equity is the value of the homeowner’s share of their home. Whatever percentage of your home’s market value that you own outright is your equity – it’s the amount you’d pocket if you sold your home tomorrow. Home equity is often represented in two ways. You may see equity as a lump sum (e.g., $120,000 on a $300,000 house), calculated as the difference between the home’s market value and the outstanding balance on the mortgage or any other liens. You may also see equity shown as a percentage (e.g., the homeowner with $120,000 in equity on a $300,000 home has 40% equity).
How Does Home Equity Work?
The simplest model of homeownership works by steadily transferring equity to the homeowner. As you pay mortgage installments over time, the lender’s interest in the property shrinks, and your equity increases, until you own the home free and clear.
But this is ultimately an overly simplistic model. For one, your home equity may increase in other ways than repaying the mortgage balance. If you complete home improvements that increase your home’s value, or even live in an area where property values rise, your equity will go up.
If you’ve been living in your home for a while, the work you’ve put in to improve your home may be about to pay off. Even the years you spent serving on the school board might lead to unexpected value. A well-kept house in an attractive community can appreciate significantly in value, meaning you might be sitting on a substantial amount of home equity. That wealth can be an important resource if you’re facing a loss of your usual income.
A realtor can run a comparative market analysis to give you an approximate idea of your home’s current market value. Property tax documents from your county appraisal district may also provide an assessed value for your home. Ultimately, the most accurate way to assess your home’s market value is to get a professional appraisal.
Selling the property and settling the mortgage is one way of drawing from your home equity all at once (although you won’t have the home anymore). But not all “house-rich, cash-poor” homeowners will have to go to those extreme lengths. Another option is converting a portion of your equity wealth into a cash cushion through a home equity loan, home equity line of credit (HELOC), or innovative products like a Home Value Investment or home equity investment.
These financing options temporarily change your equity relationship with the property, because you’re introducing another party that will also have an interest in the home. But families navigating through a period of job loss or unexpected debt may benefit from falling back on high-value assets like their home. And depending on which financing option you go with, tapping into equity can even be a no-debt solution to steer you through a lean financial stretch.
Why Use Home Equity
Millions of people took a financial hit due to the coronavirus pandemic. Families are readjusting based on changes in their jobs or college plans. Even families earning a comfortable income may find themselves in over their heads after the financial toll of the pandemic. Debt payments, including mortgage and credit card debt, can be manageable with both earners’ income. If people lose their job, take a pay cut, or reduce working hours, debt can quickly become debilitating. Depending on your situation, putting home equity funds to work for you may be an option to consider.
First off, before you open a new home financing agreement, check what options exist with your current loan. Mortgage forbearance is ending in the next few weeks for some homeowners, but not all loans work the same way. Homeowners with government-backed loans (even if you work with a bank, the loan itself may be government-backed) may have the right to request an additional 180-day forbearance extension. Even if your loan is not government-backed, a private lender who honored similar forbearance terms voluntarily may be willing to work with you on an extension, too.
Forbearance has its pros and cons, so it will be the right choice for some homeowners and not ideal for others. An important downside to forbearance is that it’s not the same as forgiveness – you’ll still accrue interest, and you might end up with more challenging payments once you start paying mortgage again. Get all the information about eventual payment terms. The lender may require a one-time “balloon” payment to catch up, raise monthly payments for a set amount of time, or extend the term length of the loan. All of these can have different effects on your ability to meet payment terms, and even on your credit score.
Drawing from your home equity offers financial flexibility to use the funds however you see fit. Depending on the terms of your mortgage versus a home equity financing agreement, you may find an option that’s easier to pay than an adjusted mortgage or lump payment with interest down the line. Some equity financing agreements may also have less negative impact on your credit score than mortgage forbearance.
When to Use Home Equity
When you should access your home equity is a complex decision that varies from family to family. It’s helpful to work out a financial timeline for your family, so you know when to use home equity and when to buy out a partnering company’s investment (like Noah’s). The timeline can include important dates for milestones like college graduation, or a schedule to get out of debt.
Home equity funding can make it easier to pay for these common expenses:
- Home improvements: Improve your experience living in your home and increase your property value by making improvements to your home.
- Higher education costs: Paying college tuition can be challenging, especially if you lose your job unexpectedly.
- Debt consolidation: Talk to a financial advisor about the best ways to consolidate debts and handle major payments, like a balloon payment on a deferred mortgage.
- Personal business: If you’re launching your own business, you might need capital to get on your feet.
- Second property: Home equity can help you fund a down payment for a different property.
- Supplement retirement funds: If you’re not ready to withdraw retirement funds but need supplemental income, home equity might help close the gap.
- Emergency fund: Living through 2020 has taught many families to expect the unexpected and have funds ready on hand
The more clearly you can list your top financial priorities, the more prepared you’ll feel to make the best use of home equity when the timing is right for that decision.
How Can You Tap Into Your Home Equity now?
Sometimes referred to as a second mortgage, home equity loans are one of the most common ways to tap into your home equity. These loans allow borrowers who have paid down a significant portion of their mortgage to access their home equity in exchange for a lump sum cash payment at a fixed interest rate. The homeowner pays the loan amount back to the lender over time in monthly installments that include accrued interest. It is worth noting that some major banks have tightened restrictions on who qualifies for a home equity loan, or even paused accepting new applications altogether as a result of the coronavirus pandemic. If other banks follow suit, it may be difficult to qualify for a home equity loan in 2020 no matter your financial situation.
If you're considering alternate ways to get equity out of your home, a Home Value Investment may be a good option for you. Distinctly different than a second mortgage, a Home Value Investment is interest-free, debt-free, and without monthly payments. Instead, a company like Noah invests in your home, and in exchange you receive up to $350,000 to use however you'd like. As the value of your home changes over time, our investment adjusts to reflect the gain or loss of your home's value. Because a Home Value Investment doesn't add to your monthly bills, some homeowners find it gives them the cash flow relief they need to get back on their feet.
Every family’s financial situation is unique. Families affected financially by the economic fallout of the pandemic will have to find strategies that work best for them. Homeowners may find that their house is one of their strongest assets to carry their family through to better days ahead.