Many Americans have significant equity in their homes, especially if they purchased many years ago and have not previously taken cash out via a refinance. In previous years, many Americans have fallen behind on their financial plans and the slow recovery has put many of us in catch up mode. The good news is that this equity can help you with the recovery process. Keep in mind that all numbers presented in this article are examples only and are not intended to represent your financial situation.
Let’s say that you have purchased your home for $200,000 and procured a mortgage for $170,000. Fifteen years later the home is worth $300,000 and your mortgage is now $300,000. You now have $150,000 in equity, up from $30,000. What should you do with this money? Here are a few options:
Consolidate other debts. While your house was rising in value, chances are your other living expenses were probably rising as well. Let us say that your house payment is $2,000 per month including taxes and insurance. You have another $1,500 per month in bills on a total of $40,000 of revolving debt. If you either refinanced into a new mortgage or applied for a second mortgage, your payments could be reduced from $1,500 to approximately $300. In other words, your total monthly obligations would be reduced from $3,500 to $2,300 or 30.0%! This analysis does not include the potential tax deductibility of the new payment.
One caution regarding this financial strategy. In this fictitious example, you are likely spreading your debt over 30 years instead of from four to seven years. In other words, there is short-term gain but also a long-term cost. This cost can be offset by reducing the savings somewhat and moving to a 20-year mortgage. In essence what you would be doing is taking some of the savings and putting it back into the pre-payment. Moving into a 15-year mortgage would have even more long-term benefit.
Re-investment of the equity. You could use the equity for investment. Right now, all the equity is invested in one place. What are other possibilities?
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