Guard Your Home Equity Carefully

The underwater mortgage

The new chronic problem with about 25% of US homeowners is having an “underwater” mortgage. The term means homeowners who owe more than their houses are worth. Due to the decline in home values as a result of the recession many homeowners are finding themselves in this position. Recent studies are showing that before the recession makes a marked change for the better, about 50% of homeowners will find themselves with “underwater” mortgages.

The good mortgage news

There is good news though, when it comes to the overall state of mortgages today. Despite the number of underwater mortgages steadily projected to grow, there is another group of homeowners who are surprisingly safe. A study by First American CoreLogic, is showing that about 23 million homeowners have 20% or more equity in their properties, and about 1 million more own their houses outright. Owners in this position are faced with the question of what to do with their equity. Although it’s great to have a good amount of equity in a property, there are two concerns that every homeowner needs to face:

  1. If homeowners borrow against their equity and home prices continue to fall, they could end up in the “underwater” position.
  2. If homeowners don’t borrow against equity, the cash that could have been taken out may disappear.

The general rule of thumb is to never borrow more than 80% of the value of a house. That way even if there is a decline in value, owners still have some cushion to protect them from losing too much equity.

What to do with equity

When it comes to figuring out what to do with equity, there are some options that homeowners look into. Debt consolidation, home remodeling and car purchasing are three things that many homeowners use home equity funds for. Though this may be a convenient option, looking at each deeper reveals how little advantage there really is to each one of them.

Debt consolidation. It’s no secret that many Americans are mired in debt. A lot of homeowners make the quick move to consolidate when they have high-interest credit. This may sound like a good idea, but in reality there is more to the equation. Once a consumer turns their debt around by putting their home on the line, they have transferred their problem into a secured debt. A better move may be to file bankruptcy because that eliminates debt altogether. The only time it’s a good idea to convert equity to a loan for bills is if the total sum owed is moderately low and the reason for the debt has been identified. Homeowners should realize what brought about the debt in the first place and commit to changing their spending habits.

Home remodeling. Another thing people with high equity look into is home remodeling. Many homeowners believe that remodeling automatically adds value to a house, but that is not necessarily true. There are some changes that will add value, but not all remodeling brings an automatic return. A rule of thumb when it comes to home remodeling is to pay with it for cash, rather than take equity out of the house. The most popular renovations are bathroom and kitchen remodeling. Each one can bring a return on investment if they are done cautiously, kept within a strict budget, and paid for predominantly with cash.

Car purchasing. Some homeowners use home equity to fund their new cars. One-hundred percent of the time this is a bad idea. Why? Because cars lose value the minute they are purchased. A general rule of thumb is to make a purchase funded by home equity only if that purchase appreciates in value. Cars definitely don’t fall under that category. If a car is a necessity and the only option is using a home equity loan, then the car needs to be paid off as quickly as possible.

Equity should not be taken lightly

Due to the high number of “underwater” mortgages out there, anyone who has equity in their property should guard it cautiously. Things like debt consolidation, home remodeling and car purchasing may sound like good ideas, but according to experts, they aren’t. It’s better to leave equity where it is than risk losing it with an unwise move.

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