Using home equity to cover expenses

Take the time to understand your options before making this decision.

Figure 1

Figure 1

Borrowing against a home’s equity is an option that consumers can take to fund a variety of expenditures. With that said, the Federal Reserve Board encourages consumers to understand the two options that are available, so you can decide if either approach is right for you.

This first option is a Home Equity Line of Credit or HELOC. This is a form of revolving credit where your home is used as collateral.  For this reason, many consumers choose to use this option for major purchases only (i.e. home repair, education or medical bills) opposed to day-to-day expenses. Things to consider with this product:

  • Use the Federal Reserve Board Home Equity Plan Checklist to compare products from different lenders.
  • The lender sets a HELOC credit limit that dictates the amount you are allowed to borrow. Many lenders will set this credit limit by taking a percentage, which can vary across lenders of the home’s appraised value, and then subtracting from that amount, the current balance owed on the existing mortgage. An example is available in Figure 1. 
  • Other factors that lenders will consider when determining your credit limit include your ability to repay indicated by income, debt and other financial contributions along with your credit history.
  • There may be a fixed time period that you are allowed to borrow the money, you may or may not be able to renew the credit line when the time period expires and there may be certain limitations such as only being allowed to draw certain amounts at a time, take an initial advance when the credit line is first set up, etc.
  • HELOCS typically involve variable versus fixed interest rates. Therefore, you should ask questions and seek guidance from a professional if you do not understand the terms. 

The second option is a Home Equity Loan (HEL).  This form of credit is committing to a traditional second mortgage.  Things to consider with this product:

  • Use the Federal Reserve Board Home Equity Plan Checklist to compare products from different lenders.
  • A HEL provides a fixed amount (lump-sum withdrawal) of money that is repayable over a specific time period.
  • HEL are typically issued with a fixed interest rate. 

In closing, there are many things to consider before making the decision to borrow against the equity in your home. Be sure to compare the costs of each product against their benefits, do your homework and shop for credit terms that best meet your borrowing needs without leading to unnecessary financial risk and remember that failing to repay what you have borrowed and the interest, could lead to the loss of your home.

For additional money management resources visit Michigan State University ExtensionMichigan State University Extension offers financial literacy and homeownership workshops throughout the year to help you become financially healthy. For more information of classes in your area, please visit either the MSU Extension events page or MI Money Health website. Additionally, you can take the Financial Health Survey at MI Money Health to access if you are financially healthy and discover more ways you can improve your financial health. 

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