4 Home Equity Mistakes That Some Homeowners Make
As a homeowner, the equity that you’ve built up in your home is quite possibly your largest asset — so it’s important that you treat it carefully. To that end, we have listed below four home equity mistakes that some people make. Read them over so that you can avoid making the same mistakes in the future.
Look out for these common home equity mistakes
1. Ignoring your loan-to-value ratio.
Whenever your home equity is up for discussion, your loan-to-value ratio should be at the center of the conversation. In real estate, a loan-to-value ratio tells you what percentage of the home you own outright. It’s a measure of how much you owe on the home compared to its total value.
Typically, lenders will not let you leverage your home equity if your loan-to-value ratio is too low. However, even when you have enough equity in your home to refinance your mortgage, it’s important to know where you stand compared to how much you owe.
If you’re not sure how much equity you have in the home, don’t hesitate to ask a lender. Otherwise, you could find yourself owing more on the home than you anticipated, particularly if you have to sell earlier than you originally planned.
2. Borrowing without understanding the loan’s terms.
If you do decide to refinance your home loan, it is absolutely crucial to make sure that you understand the terms of the new loan, including how much you’ll owe in total, the payment schedule, and what your new payment amount will be each month.
In particular, this is especially important if you’re considering doing a cash-out refinance. With a cash-out refinance, you’ll borrow more than you currently owe on the home and the difference is given to you in cash. Usually, homeowners will use this type of refinancing to fund big expenses like medical debt or education costs. However, if you decide to go this route, there’s a chance that your payment could be higher than you’re currently paying now. which could take a little getting used to.
In this instance, if you have specific questions, it’s best to talk to your lender before you take out the loan. Once you sign on the dotted line, you’ve committed. To that end, make sure you ask plenty of questions ahead of time to avoid any home equity mistakes.
3. Not researching the new tax deduction rules.
Previously, all homeowners could deduct mortgage interest on up to $1 million of debt on their tax return. However, with the passage of the Tax Cuts and Jobs Act in 2017, that rule changed.
Now, you can only deduct interest on that amount of mortgage debt if your loan was originated before December 14, 2017. If your loan was originated after that point, you’re limited to deducting interest on only up to $750,000 worth of mortgage debt.
Often, homeowners get tripped up by these new tax rules when they refinance. However, it is important to realize that refinancing will not change your tax filings. The amount of interest that you are allowed to deduct depends on when the loan was first placed on the home. In short, refinancing does not reduce the amount of interest that you are allowed to deduct.
While there’s always the chance that these tax rules could change under the new administration if you have questions about deducting interest on this year’s returns, your best bet is to talk to a tax professional. He or she can listen to the specifics of your situation and give you individualized advice.
4. Using equity to consolidate debt.
Lastly, occasionally, people will decide to use the funds from a cash-out refinance in order to consolidate debt. It may sound like an ideal solution since you can often streamline your payments at a low-interest rate — and for some people, it can be.
In truth, borrowing against your home to pay off personal debt is a dangerous habit to get into if you don’t have control over your spending habits. Unless you truly make an effort to change those habits, there’s no guarantee that you won’t run up another balance. If that happens, you’ll likely find yourself in an even tougher situation than before.
Whenever possible, you should avoid tapping into your home equity to manage your day-to-day spending. Home equity is usually meant to be used for big, unavoidable expenses like higher-interest medical debt.
The bottom line about avoiding home equity mistakes
Borrowing against your home equity can be a smart financial solution if done responsibly. However, if not, doing so can also be more trouble than it is worth. With that in mind, if you’re thinking of leveraging your home equity to cover costs, it’s best to talk to a financial professional first.