A home equity loan is a hidden source of finance that many fail to access. Worse, fewer people know how to utilize this hidden financial resource, and as such plunge themselves further into debt. However, if we have a detailed plan, we can use home equity loans to accelerate our financial goals and achieve financial independence at a faster pace.
What is a home equity loan?
Home equity is simply the difference between what you owe on your mortgage and what your house is worth. For example, if you owe a $250,000 mortgage on your home, but the price of your house when it is out on the market is $450,000, your home equity is the $200,000 difference. A loan taken against this amount differential is a home equity loan.
A home equity loan is akin to taking another mortgage. You borrow a certain percentage of the equity you own in your home and repay the lender at a fixed rate over a stipulated period (usually 10 to 15 years).
If you already have a mortgage on your home, the home equity loan can be structured as a second mortgage. Though it would attract a higher interest than what you accrue on a regular mortgage, the rate is generally lower than a personal loan.
Home equity loan: A double-edged sword
Using a home equity loan allows you to turn that dead capital into a profitable financial investment. A home equity loan allows you to borrow as much as 85% of your equity in your house.
Whether a home equity loan is a good idea ultimately depends on what you intend to do with the cash. Because the loan is secured by the home, this comes with the higher risk of losing your home if you can’t pay up. Plus, the loan also comes with interest.
These are some of the factors you have to consider before taking an additional loan against your house. They can also act as guidelines on how best to deploy the capital you have obtained from your home equity loan. Below are some smart ways you can use your home equity loan.
#1. Starting a business venture
The best way to use a home equity loan is by investing in something that would generate more cash. You are already taking on more debt, with added interest plus the possibility of losing your home.
You need to hedge these added financial risks. The best way to do that is by increasing your cash flow. The additional income that comes from here can ease the financial pressure and reduce the effect of the burden.
Opening a business venture is one way you can increase your cash flow. Because of the high rate of failure for new businesses, ensure that you are starting a business you know very well or you have done due diligence and conducted feasibility studies.
#2. Invest in the stock market
Though the stock market comes with no guarantees, historical records show that the longer the time you spend in the market, the higher your possibility of having profitable returns. For example, the S&P 500 has returned 105% in the last five years. That means if you had taken out a loan against your home equity 5 years ago and placed it all in the S&P 500, you would have more than doubled your money.
To reduce the risk that comes with market volatility and corrections, you can stay away from penny and meme stocks as these stocks can experience sharp price declines which could hurt your investment.
Another strategy you can deploy when using your home equity loan is Dollar Cost Average. Instead of investing the lump sum in the stock market, you can invest in installments at specific periods or when there is a downturn in the market. Using DCA reduces the average price of stocks thereby increasing your margin for profit.
#3. Invest in real estate
You can also use the equity in your home to acquire a new property. You can decide to go into rentals or develop and flip properties. The best time to do this is when interest and mortgage rates are low as this reduces the interest you pay on the loan. Though this may also affect the amount you can accrue from your property, the key point is that it is generating additional cash flow. If done efficiently, you can use the proceeds from your rental to pay your home equity loan and your first mortgage.
#4. Reduce your existing debt
The equity in your home can also be unlocked to accelerate your financial stability, by using it to eliminate any existing debt you may have. While this seems like you are trading one debt for another, using your home equity may help you get out of debt faster. The home equity loan comes with a lower interest rate because it is collateralized. The money from here can be used to offset these high-interest loans like credit card debt and personal loans that have a higher interest rate, thereby reducing the overall money you would pay back.
#5. Invest in home improvements
This is a popular decision among many homeowners. On the surface, this may seem like you are taking on additional expenses, but the fact is investing in home improvement creates more value which increases the price of your home in the market. It also is a cost-effective way of improving your home without burdening yourself financially since the duration can be stretched for a long period.
Taking out a home equity loan can be dicey, but if you have a game plan, you can increase your net worth. Taking a home equity loan is a convenient, low-cost way to borrow large sums. Plus, the interest rates are lower which makes them favorable. The key is using the proceeds from the loan to generate more cash (like opening a business or investing in stock) or clogging financial waste pipes (such as paying high-interest debts).
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