For many people, a home is much more than just a place to live. It's often one of your greatest financial resources and a cornerstone of your family's history. Understanding how to use this asset wisely can be a game-changer for your financial journey, but it requires a careful balance of opportunity and risk.
Generating rental income from your space
There are two broad ways your home can put money in your pocket. The first is using it as collateral for a loan, and the second is using it as a source of rental income.
In many municipalities, you can rent your entire home or just a portion of it. This is especially handy if you're already working with an in-law suite or a semi-private living area with its own bathroom and kitchen facilities. Many homeowners choose to rent to students or others for short-term income.
If you decide to go this route, make sure you check your local zoning and rental laws first. It's also vital to have a signed lease or other written rental agreements in place. We recommend talking to your CFP® professional or tax professional about how to manage the taxes and other expenses that come with being a landlord.
What is home equity and how do I calculate it?
You can also put money in your pocket if you have equity in your home. This can come in the form of a lump sum or a line of credit.
Here's how the math works. If your home is worth more than the amount you owe on your mortgage, that difference is considered the amount of equity you have in your home. So, if your home is worth $500,000 and your mortgage balance is $300,000, you have $200,000 in equity.
There are several ways you can convert that equity into usable cash.
Four ways to access your home's value
If you've built significant equity in your home, there are generally four paths to converting it into money you can use:
- Sell your home
- Refinance your mortgage
- Take out a home equity loan
- Open a home equity line of credit (HELOC)
Selling your home has one obvious drawback. You'll need a new place to live. However, for people who are downsizing or moving to a less expensive area, the equity they receive from selling their home may cover some or all of the costs of a new property.
The potential benefits of refinancing
Refinancing your mortgage is another popular option that can offer several benefits depending on your goals.
Lower your interest rate
Depending on the current interest rate environment and when you secured your original mortgage, you may be able to refinance at a lower rate. Securing a lower rate means you'll pay less in interest over time, which can free up cash flow for other parts of your financial roadmap.
Lower your monthly payment
In some cases, extending the term or length of the loan will lower the payment as well. For example, paying off a loan over 30 years instead of 20 or 25 will result in a lower monthly payment. While this extends your debt timeline, it can provide immediate monthly relief.
Convert equity into cash
If the balance owed on your mortgage is significantly less than your home's value, you can refinance your mortgage for more than you owe and put the difference in your pocket. However, there's a limit. The recommendation is not to go above 80% loan to value (LTV). This means the loan isn't more than 80% of the value of your home. Most lenders won't even lend you more than that because loans for more than 80% of the value of your home are riskier for them and for you.
Make sure you also check the fees. Refinancing can carry significant fees, so you need to determine if the monthly savings will truly pay off down the road.
Home equity loans vs. lines of credit
A home equity loan or line of credit are essentially second mortgages. It helps to understand the difference in how they're structured.
A home equity loan is typically a lump sum that you receive right away. This is often useful for a specific, one-time expense where you know exactly how much you need.
A line of credit (HELOC) is a sum of money you can draw on whenever you wish, similar to a credit card but secured by your house.
In some cases, it makes sense to set up a line of credit even if you don't need the money now. There are typically minimal fees to open one, and that line of credit can act as a financial safety net later if an emergency arises.
When does it make sense to borrow against your home?
Just because you can borrow against your home doesn't mean you should. It's important to distinguish between needs and wants.
Smart uses for home equity
Borrowing against your home to pay for home improvements is generally smart, especially if those improvements will increase the value of your home.
You might want to unleash your inner chef and transform your kitchen into a family gathering place. Maybe you want to finally expand that cramped bathroom with the pink and green tile. Or perhaps it's time to give your teenager some privacy. Your home can help you pay for the improvements you and your family will enjoy for years to come.
Another potential use is debt consolidation. If you have significant credit card debt at a high interest rate, the equity in your home can help you consolidate those debts at a much lower interest rate. Keep in mind, though, that this is usually best used as a one-time reset. You don't want to pay off your credit card balances only to run them up again.
When to think twice
If you're tapping into your home's equity to fund a want rather than a need, such as to pay for a vacation, you should think twice. That may be a sign that you're living beyond your means and should rethink your budget.
Keep in mind that any time you use your home as collateral for a loan, you're taking a risk. If you can't pay off that loan, the lender can seize your home. This isn't a transaction to enter into casually.
The Facet difference
At Facet, we're changing the way people experience financial advice. We believe your home is a vital part of your overall financial picture, not just an isolated asset. We don't sell loan products or make commissions on your decisions. Instead, we act as an objective guide to help you understand how tapping into home equity impacts your entire life.
Our membership model includes an expert team led by a CFP® professional who works with you to build a personalized roadmap. Whether you're renovating a kitchen or consolidating debt, we'll help you weigh the risks and rewards so you can move forward with confidence.
