Home prices are up—What should homeowners do?
Like many homeowners I work with, you see the value of your property increasing and may be wondering if there’s anything you should do from a financial planning perspective. The answer depends on your specific situation, but here are several options to consider.
Home equity (your home’s value minus your mortgage balance) is part of your overall net worth, but you may not want to consider it as a source of usable money unless truly necessary or if you decide to move. After all, eventually paying off your mortgage can have a big impact on your spending needs and tax-planning options once you reach financial independence.
Paying off high-interest debt with a low-interest home mortgage can make sense in certain situations. And investors comfortable with higher risk may consider using home equity to buy investments expected to return more than their mortgage interest rate. However, the downside is you could lose your home if things don’t work out, and you will always need a place to live!
Get rid of mortgage insurance
You may be able to save thousands of dollars if you have a conventional mortgage and purchased your home within the last couple years with less than 20% down. These homebuyers are required to carry private mortgage insurance (PMI) until monthly payments increase equity above 20%. But rising home values can offer a faster way to hit that 20% target.
If your home equity percentage (home equity divided by your home’s value) is now above 20%, contact your mortgage provider and ask about removing PMI. You also will need a good payment history and no other liens on the property. The mortgage insurance company may likely require you to pay for a new appraisal, but that should only cost hundreds for you to save thousands. However, first check to see how close you are to reaching that 20% mark thanks to your regular monthly payments. If you’re on track to reach 20% in just a few months, it may not be worth the extra cost for an appraisal.
Sell and buy or rent another home
Rising prices and your monthly principal payments each contribute to the home equity you can use for a down payment on your next home. This can be an essential source of funds, especially if you plan to buy a more expensive home. Selling also frees up equity for other purposes if renting makes more sense for your housing needs.
Access your home equity
The growing equity in your home can be used for other purposes, but taking cash out comes with additional expenses and risks. A cash-out mortgage can run you several thousand dollars in closing costs, as well as increase your monthly payments and the overall length of your loan. And if home values decline and you are unable to pay your monthly mortgage bill, you might risk losing your home.
If you’ve weighed the costs, benefits, and risks carefully, here are some common ways to access your home equity:
- A home equity line of credit (HELOC) provides you access to your credit as you need it, and you only pay principal and interest on the amount you borrow. Interest rates are variable and typically higher than what might be available through traditional refinancing.
- A home equity loan, or second mortgage, gives you a lump-sum amount of money, and you make principal and interest payments on the full amount borrowed. This type of loan can have a fixed or variable interest rate, and repayment terms typically range from 5 to 30 years.
- Cash-out refinancing is an option if you decide to replace your primary mortgage to also get a lower interest rate or change the repayment terms, like going from a 30-year to a 15-year loan. This type of mortgage typically offers the lowest interest rates that you qualify for based on your income and credit rating, and interest rates can be fixed or variable.
- A reverse mortgage may be an option for homeowners who are at least 62 years old and own their home outright or owe very little on their existing mortgage. This option allows you to borrow against your home equity and receive regular payments over time. The loan typically is repaid when the home is sold, either when you move or from your estate when you pass away.
Homeownership has been an effective way to build wealth over time, and that wealth is magnified when real estate prices rise faster than the pace of inflation. While it may be tempting to tap into your growing home equity now, pulling cash out can undermine longer-term goals like purchasing a more expensive property or eliminating debt once you reach financial independence.
Talking to a comprehensive financial advisor can help you understand how home ownership fits in your broader financial plan, if rising equity can help you eliminate PMI payments, and how to best access home equity if it makes sense in your specific situation.
Tim Drake helps individuals and families build and align their finances for living a fulfilled life. Working with integrity and mutual respect, his comprehensive process includes investments, debt and cash flow management, insurance, and tax, retirement, and estate strategies. He is a Senior Financial Advisor at Pegasus Financial Planning, a fiduciary, fee-based Registered Investment Advisor (RIA).