For many people, a home is not only a place to live, but one of their greatest financial resources. Used the right way, it can be a valuable asset in making the most of your financial life.
There are two broad ways your home can provide not only a place to live, but money in your pocket: Your home can be collateral for a loan, or a source of rental income.
Generating rental income
In many municipalities, you can rent your home or a portion of your home. This is especially handy if you already have an in-law suite or a semi-private living area with its own bathroom and kitchen facilities. Many homeowners rent to students or others for short-term income.
If you do this route, make sure you check local zoning and rental laws. Make sure you have a signed lease or other written rental agreements. And talk to your CERTIFIED FINANCIAL PLANNER™ professional or tax professional about how to manage taxes and other expenses.
Borrowing against your home
You also can put money in your pocket, either in a lump sum or as a line of credit, if you have equity in your home. Here’s what that means.
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 money in your pocket. And you can also use your home to generate monthly income.
Here’s how to tap into your home’s value.
If you have significant equity in your home, there are several ways you can convert some of that equity into money in your pocket:
- 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: now you 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 home.
Refinancing your mortgage
Refinancing your mortgage can have several benefits:
Lower your interest rate and your interest costs: if your mortgage is a few years old, chances are you can find a lower rate today. That means you’ll pay less in interest over time.
Lower your monthly payment: In some cases extending the term, or length, of the loan will lower the payment as well. Paying off a loan over 30 years instead of 20 or 25 will result in a lower monthly payment.
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 get cash in your pocket. However, there is a limit. The recommendation is not to go above 80% loan to value, meaning the loan is not 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 more risky for them (and you).
Getting a home equity loan or line of credit
A home equity loan or line of credit are essentially second mortgages. A home equity loan will be a lump sum that you get right away. A line of credit will be a sum of money you can draw on whenever you wish.
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, and that line of credit can act as a financial safety net later.
Fees
Refinancing your mortgage can carry significant fees, as can taking out a home equity loan. Make sure you know the costs associated with the refinance so you can determine if the monthly savings will pay off down the road.
When to tap into your home’s equity
Just because you can borrow against your home doesn’t mean you should. For example, if you have significant credit card debt at a high interest rate, the equity in your home can consolidate your debts at a much lower interest rate. Keep in mind, though, that this is usually best-used as a one-time reset. Don’t pay off your credit card balances and then run them up again.
Borrowing against your home to pay for home improvements is generally smart, especially if those improvements will increase the value of your home. You can unleash your inner chef and transform your kitchen into a family gathering place. You can finally expand that cramped bathroom with the pink and green tile or give your teenager some privacy. Your home can help you pay for the improvements you and your family will enjoy for years to come.
But if you’re tapping into your home’s equity to fund a want, rather than a need, such as to pay for a vacation, 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 is not a transaction to enter into casually.
