Summary
6 Common Mistakes of Homeowners
- Making refinance the only way.
- Using home equity as the main source of monthly cash flow
- Using home equity to pay off debts, even those with lower interests
- Taking out too much
- Using home equity to buy luxuries
- Ignoring the details
Many of us who have owned a home for at least a couple years are sitting on a lot of home equity because of the run-up in home prices over the past decade (even if we also feel poorer day-to-day, because of increased prices…). This has created new opportunities for homeowners to grow and maintain wealth, when done thoughtfully.
There are also many pitfalls that homeowners ask me about. So, I put together this list of six common mistakes to avoid when thinking about accessing your home equity.
1. Don’t refinance your primary mortgage into a higher interest rate to pull out cash, unless you’ve carefully run the numbers
When you access equity via a “cash out refinance,” the interest rate on your entire mortgage resets to today’s market. Today’s rates are almost certainly higher than what you already have, which very likely means you’ll be losing money — even if you plan to responsibly use the cash you take out to make an investment, renovate your home, or consolidate high interest debt. There are other home equity products you should consider instead, like a HELOC, home equity loan, equity share agreement, or reverse mortgage.
2. Don’t use home equity to solve monthly cash flow problems
It’s generally not a good idea to use home equity to resolve ongoing, month-to-month shortfalls in your household budget. Although equity share agreements and reverse mortgages are an exception, usually when you access home equity you’ll be taking on monthly payments and failure to keep up will leave you further in debt.
3. Don’t use home equity to pay off other debt, unless that debt has a higher interest rate
The main benefit of accessing cash from your home equity is that the interest rate on the loan is low compared to other types of debt. But, that’s not always the case. For example, student and auto loans often have low interest rates that are close to the rates for accessing home equity. In that case, you won’t benefit — especially when you consider any costs you pay up front.
4. Don’t take out too much
Companies that offer home equity products will have their own limits for how much money they’ll be willing to offer you. It depends on factors like your credit score and loan-to-value ratio and the company’s risk tolerance. But, just because a company will offer you a larger amount doesn’t mean you should take it. As a rule of thumb, try to leave 20% of your home’s value untouched — e.g., $80k on a $400k home — to leave a safe buffer for changes in the market.
5. Don’t purchase goods or experiences
Think of home equity as wealth, not spending money. So, my rule is that wealth should be used to build more wealth — whether by saving money or investing in an asset that is going to increase in value. I love experiences and nice things as much as anyone. But, I stand firm that we should set aside income to save for those, separately.
6. Don’t ignore the details
Accessing home equity is complicated, and it’s hard to figure out which product is right for you. Even the terminology is confusing, and most financial advisors and real estate agents can’t help. There are dozens of companies offering different financial terms, structures, risks, and benefits. What’s right for you depends on your unique situation, and looking at the numbers really matters.
Get personalized, unbiased information
At House Numbers, we specialize in helping you consider these options.
