Using Home Equity to Finance Summer Projects

By: Jeff Hammerberg

Summertime is right around the corner. And with the right amount of cash on hand we can take full advantage of travel and vacations; complete a long list of to-do projects around the house, or pay for all those amenities, gadgets, and toys that make summer more enjoyable.

But playing in the sun and surf usually shrinks our income rather than plumping it up, so the season always presents us with a challenging contradiction: Do we sacrifice our summer pleasures or wipe out our savings? Rather than succumb to the urge to depend on credit card debt to finance the fun and play now but pay later, it may be a better strategy to tap into the equity that is still hibernating within your home. That way you can have your cake and eat it too, by increasing your cash flow without necessarily putting your budget or savings at risk.

For some consumers, taking out a home equity loan or doing a mortgage refinance will actually increase their net savings. For example, if you are caught in an expensive interest-only or adjustable rate mortgage you can bail out by refinancing into a safer and less expensive 30-year fixed rate mortgage. Those who are getting walloped by credit card interest can take out a less expensive home equity loan as a good way to consolidate and pay off those double-digit credit card rates.

Just calculate the average of the rates you’re paying now and compare that to available home equity or refinance rates to determine your savings. If you are paying 16 percent in credit card interest and can qualify for an 8 percent equity loan, for example, you’ll automatically save 8 percent. And if you have an adjustable rate mortgage about to reset, you can refinance to a fixed rate in time to avoid the spike in your monthly installments. You’ll pay some closing costs to refinance, but you can also calculate your savings rate on those by dividing your costs by the amount you’ll save each month. For instance, if you can save $100 a month by refinancing and the closing costs to do so are $1,500, it will take you 15 months to break even. Each month after that you’ll gain net savings of $100. Stay in your home for 10 more years and you’ll save about $12,000.

To generate cash through home equity for kitchen upgrades, tuition, a new car, or a European vacation – in other words, for whatever expenses you foresee – you have at least three choices:

Cash-Out Refinance

The “cash-out” refinance is a great option for those homeowners who have lots of home equity. If you owe $150,000 on your mortgage but your property is worth $350,000, for example, you can pay off the existing $150,000 by refinancing. But a cash-out refinance means you borrow more than $150,000, using the surplus for whatever you want.

Borrow $250,000, for instance, and you’ll walk away with an extra $100,000. Your monthly payments will increase, but the benefits may justify the added expense – especially if you invest the money your borrow wisely or refinance into a better mortgage in the process (such as switching from an ARM or negative amortization loan into a 30-year fixed rate mortgage).

Home Equity Loan (or 2nd Mortgage)

Home equity loans or 2nd mortgages typically carry higher interest rates than first mortgages, but have little or no closing fees. And while refinancing can take a month or more to finalize, applications for home equity loans are simple and loans can usually be funded within a week or two. These are a good choice if you have major expenses – such as opening a business, renovating your home, or buying a vacation property – and you want to stretch repayment over a period of several years.

Home Equity Line of Credit (HELOC)

The HELOC is an open-ended mortgage that behaves much like a credit card. You borrow what you want, when you want it, and if you only pay interest on the amount you borrow. Typically there are no fees to open a HELOC, and if you choose not to use it you won’t be charged any interest. Use it and then pay it back and your credit limit goes back up so you can borrow it again if you want to. HELOC loans, like credit cards, are convenient for short-term financing of smaller purchases. But the interest you pay on your HELOC will likely be considerably less than typical credit card interest rates.

Keep in mind that all mortgages and home equity loans are secured by real estate, so if you default on these loans you can put your property at risk. Take advantage of borrowing against your residence only when you have a repayment plan and sufficient financial strength to pay back – in a timely manner – any obligations you might incur.

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