and cons of using your home's equity
Stacee Sledge, for The Bellingham Herald
the magic word that moves so many to eagerly enter the real
Many of us
have heard the popular reproach: "Stop renting and buy
yourself a house. Then you'll be building equity, rather than
throwing your money out the window every month."
you've followed that age-old advice and can access equity of
your very own, what should you do with it?
to Realtor Larry Humes of John L. Scott Real Estate, homeowners
do a wide variety of things with equity —
many of them, he says, not so smart.
first thing about a home's equity is, first and foremost, be
very careful with it and be very careful of it," he says.
For many homeowners, the best way to use equity is to not touch
it at all, until you're ready to sell and move up to a larger
home or use the cash to retire.
understands equity intricacies inside and out and warns that
many homeowners use equity while they're still living in the
home in ways that simply don't make financial sense. He's quick
to point out equity can be used in beneficial ways, but it's
vital that you do your homework before you move forward.
in capital gains taxes
delving into the equity dos and don'ts, it's important to clear
up a common misconception about capital gains tax laws, which
changed drastically five years ago.
biggest mistaken belief about equity derived from the sale of a
personal home is that you must reinvest that income or risk
paying capital gains tax. No longer true. Tax law changes now
allow any homeowner to sell a home every two years and take a
$500,000 exemption per couple or $250,000 exemption for a single
person. The only restriction is that the seller must have lived
in the home two out of a total of five years.
meet these requirements, any profit you make on the sale of your
home is yours to spend however you like. You can go on a long
trip, buy a motor home, purchase stocks, invest in other real
there are no limitations placed on that money.
record-low interest rates and record-high instances of
refinances in recent years, more homeowners are using equity to
eliminate credit card debt, buy vehicles or update their home —
without putting their home on the market.
advises that if you decide to access equity without selling your
home, carefully consider what you're planning to purchase with
the cash and raise the important question: Does it create an
asset or a deficit? "Whatever that thing is, does it become
something that pays or does it become something that decreases
mortgages happen regularly," says Humes. "Second
mortgages happen in the middle of the night. Someone will see on
TV [a commercial that says] 'We can give you 150% of the value
of your home!'"
should turn the TV off at that point."
homeowners have been taken in by such commercials and all that
they promise. And those late-night ads have helped contribute to
the highest incidents of foreclosures
attributes this to a mentality of spending that's problematic
for many people who take out a second mortgage based on the
equity in their home.
I see out there is home loans that are at 90 or 95
percent," says Humes. "Somebody came in with 0% down
or 3% down or 5% down, and then went out and got a second
mortgage to pull their equity out and used it to put a new roof
on, to put a deck on the back, or to buy a new truck."
stresses that these second mortgages never offer interest rates
as good as the first. And they're all variable rate, so they can
float. "If the interest rate bumps up, all of a sudden the
second mortgage is big and ugly," he says. And no longer
affordable to many homeowners already drowning in consumer debt —
which is also at an all-time high.
occur a lot of times because people get stressed about the
second mortgage and stop paying it," Larry says.
brings Humes back to his views about the spending mentality of
many homeowners today. "Once somebody does a second
mortgage and shifts their mentality toward a spending mode, they
usually continue. It's not really whether they put a new roof on
the house or not, it's a mental shift. Once they've done that,
it's like they've got this free money and they've got to do
something with it. And when it runs out, the mode is still
it's become increasingly common for a Realtor to pull up a
profile on a house that's in foreclosure to find, for example, a
$150,000 loan taken on a $165,000 property that also has a
$35,000 second mortgage —
far beyond the value of the house.
popular reason for accessing equity these days is to pay off
credit card debt. It sounds like a winner, since oftentimes the
interest can be considered tax deductible. But Larry again
sounds a warning bell.
pay off your credit cards," Humes insists, admitting that
this opinion may differ from that of other professionals, and
then continuing on to make a compelling case.
happens when you pay off a credit card is you'll end up paying
off [the debt at] a higher interest rate," he explains.
There is a tradeoff point, Humes admits. "If you've got 18%
or 20% interest on your credit card, it can make sense to pay
them off. But if you have an 8% or 10% interest rate, don't pay
them off with home equity. Because you're going to end up
zeroing out that credit card, but you're going to pay that
balance for maybe 20 or 30 years, instead of paying it off with
a two or five year plan. The eventual interest is huge —
even with a lower interest rate."
go out and buy a boat or car," says Humes. "Because in
five or ten years what you've got is something that doesn't have
much value and you've still got 10 or 20 years of paying for
buy appreciable assets that pay for themselves. Humes says real
estate is a great investment, with limits.
buy land —
just land —
where you use equity as a down payment and have to make a
monthly payment." Unless you have a short-term plan for the
land, or absolutely know that it's in the way of progress and
within two or three years will become much more valuable, it's
not a solid appreciable asset to invest in.
would say buy rental investment property," says Humes,
"because the tenant then pays the monthly payments and the
property increases in value." But he strongly suggests
contacting someone who can analyze the property before you make
believes purchasing rental property anywhere in the county is a
better bet than in
today's current market.
you can buy a duplex in
or a duplex in Everson," Humes says. "The duplex
$210,000; in Everson it's $135,000. The rents in
while the rents in Everson are $550. Makes perfect sense to me —
I don't have to figure that one out very much. I buy rentals
anywhere and everywhere I can, but I don't touch them in
at this point; they're out of hand."
smart way to spend equity is to remodel your home, but again
it's best to think it through carefully before knocking down
plaster walls or ripping out plumbing.
are two reasons to remodel," says Humes. "One is to
get what you want and to heck with the next guy and to heck with
resale ability. The other side of it is to fix a place up real
nice and sell it and do really well. Two totally different
remodeling projects will pay you back in full —
and then some —
when it comes time to sell your home. According to Humes,
runs at about 105% return on remodeling dollars spent on
kitchens, master bedrooms and master bathrooms.
are many remodeling projects that won't pay 100% of what you put
into it, such as basements and landscaping. Humes suggests
mining the web for information on which remodels pay off best.
although those late-night television commercials Humes mentioned
might appeal in the dim glow of the talking screen, wait until
the light of day to make a decision. Think about how you want to
use the newfound cash and make sure it makes financial sense.
Then, meet face to face with a qualified professional before
signing on the dotted line.