In the Universe of superheroes like Spiderman and Captain America, the characters all have a superpower that allows them to rescue the innocent, fight evil and prevent catastrophes from destroying the Earth. Here in our Universe, the amazing increase in home values across the nation over the past five years has given ordinary people like you and me our superpower called Equity. The increase in our home’s value since we bought it (referred to as equity) can allow us to do special things too, and many of our friends and family are putting their equity to work for them while mortgage interest rates are still low. Your home’s equity can be harnessed to help you create new wealth by using it to buy rental homes and invest in new businesses. Many of us use our equity to consolidate our debts or go back to school to jump-start our careers. I’ve met many homeowners who have used their equity to spruce up their homes with new flooring, appliances, or even by adding a swimming pool. Others use their equity to do badly needed repairs to their homes and the preventative maintenance that they have been thinking about like installing a new roof or replacing old air conditioning units. Finally, many of us who have discovered how much Equity we have converted a portion of that into cash that can be added to existing retirement accounts. If you own a home, you have the power to do many wonderful and worthwhile things with your equity!
Using the power of your equity to invest in real estate or to start/expand an existing business is a popular trend across the country. The various types of loan programs available to you include Conventional loans underwritten by Fannie Mae and Freddie Mac, FHA loans which are guaranteed by the US Federal Government, VA loans which are available to qualified veterans and active duty service members of the US military, and Non-Conforming loans, also known as Portfolio loan programs. In general, you are permitted to borrow up to 80% of the value of your home when you are taking equity out of your home. This type of refinancing of your existing mortgage is called a Cash-Out refinance, and although this type of loan is typically offered at a higher rate of interest compared to a purchase mortgage or “Rate and Term” mortgage, where you are simply looking to lower the rate or term of your existing financing, the fact that you are stopping at 80% of the home’s value allows us to avoid the cost of mortgage insurance on conventional loans. If you use FHA or VA financing to take cash out of your equity, you will likely be subject to some form of mortgage insurance known as a Mortgage Insurance Premium or Funding Fee. Thus, it is often preferable to use Conventional financing to access your home’s equity via a cash-out refinance in most instances. That being said, FHA and VA cash-out refinancing has its place and maybe the right choice for some consumers. For instance, FHA can be the right choice for a borrower with a lower than average FICO credit score, and VA may be right for the Veteran looking to take out more than 80% of their home’s value.
When using your home’s equity to pay off debt, make repairs to your home, or remodel, it’s interesting that many borrowers can accomplish multiple goals at once. For instance, many people bought their homes in the past few years with a loan that required private mortgage insurance (PMI). This means that their monthly mortgage payments include a monthly fee for PMI. With home values skyrocketing recently, there may now be enough equity in the home to consolidate debts, do home repair and remodeling, and eliminate the PMI. A close examination of your debts, current mortgage payment, repair and remodel plans/costs and your home’s equity can be done by your mortgage loan officer to determine your best options. There is a “Cost-Benefit Analysis” that can help you determine if using your equity in this manner makes sense. By adding up the required monthly payments you intend to consolidate and then determining the monthly savings you will derive from this action, you know your benefit. The cost is the cost of obtaining new mortgage financing including origination fees, appraisal fees, title and escrow fees, and credit report costs. This identifies your cost of taking this action. By dividing your costs by your benefits, the loan can be determined to provide you with a tangible benefit if the break-even period is 36 months or less. For instance, a loan that saves you $500/month and costs $3,500 in fees pays for itself in just 7 months. This would be a no-brainer good idea. Conversely, a loan that only saves you $75/month and costs $3,500 would take 46 months to break even, thus would not be a good plan. Finally, the benefits of taking cash out of your equity to do maintenance, invest in other properties or businesses, or remodel cannot strictly be judged with this type of cost-benefit analysis but may still be a really good idea. You’ll need to evaluate this with the help of your financial advisors and loan officer. One customer used the equity in their home to undergo en Vitro fertilization which resulted in a new baby being born a year later. The can’t put a price tag on the incredible joy they experienced by using their Equity Super Power.