How your home can help you renovate your finances

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A house is more than a place to live and raise your family. Here are some ways the equity you've built up could help you pursue other important goals.
— by Kathy Kristof

Key points

  • Your home may be one of your largest assets, so it's important to understand how it fits into your larger financial picture
  • You may have substantial equity in your home, which you may be able to use to help you pursue your goals
  • There are three main ways to tap your home equity: HELOCs, HELOANs and a cash-out refinancing
When I told my 19-year old son that I'd decided to sell the house he'd grown up in, his usual tough-guy act evaporated. He and three friends sat in my kitchen and wiped away tears. If the near-acre of land on which our two-story home sat had been easier to maintain — or if there were kids still living in any of the four bedrooms — I might have had a change of heart then and there. Instead, I took a deep breath and asked them to trust me.
Clearly, downsizing from my empty nest to a smaller, more affordable home was a smart financial decision. But it was also a very tough one emotionally. "People might know intellectually that their home is a financial asset, but they think of it in emotional terms — as the place where they raised their kids, where they want to grow old," says Gao-Wen Shao, Director of Retirement Solutions at Merrill. Still, Shao adds that ignoring an asset that may be worth hundreds of thousands of dollars would be a mistake. "It's critical that you examine all the financial resources you can bring to bear when figuring out a plan for pursuing your goals," agrees Lorna Sabbia, Head of Retirement & Personal Wealth Solutions at Bank of America.
Graphic showing three ways to take equity out of your home. Featuring a chart with three different options for cashing out your equity, the graphic highlights the following attributes for each one: what you get, the interest rate, similarities to other financial options and risks to consider. The first option is a home equity loan. What you get: A lump sum in cash, backed by your equity. Interest rate: Fixed (usually). Similar to: A second mortgage. Risks to consider: Borrowing more than you need. The second option is a home equity line of credit. What you get: Access to cash as needed during the term of the loan, up to a set amount. Interest rate: Variable (usually). Similar to: A credit card that's secured by your home. Risks to consider: Interest rate increases. The third option is a cash-out refinance. What you get: A new, bigger mortgage, and the chance to cash out part of your home equity. Interest rate: Can be fixed or variable. Similar to: A mortgage (because that's what it is). Risks to consider: Decline in the value of your home; taking on additional debt; potentially more interest over the life of the loan.
So what role should your home play in your overall financial picture? And how can you take advantage of the home equity you've built up?

Is home ownership a good investment?

Thanks to the equity I'd built up, I ended up with a nice profit when I sold my home, but not everyone is so lucky. How much equity you have in your home is largely dependent on how long you've owned it, how large your initial down payment was and how high home prices are in your area at any given time.
Your home might end up being the biggest asset on your balance sheet.
— Matthew Diczok,
Fixed Income Strategist,
Bank of America
"Home price appreciation has been slowing since the middle of 2018 as prices in some regions became too high relative to income growth," says Michelle Meyer, Head of U.S. Economics at BofA Merrill Global Research, adding that national home prices are expected to settle at a 3% year-over-year pace. This aligns with the fact that, over the long term, the typical home only appreciates 3% to 4% per year, according to the Federal Housing Finance Agency.Footnote 1 Stocks and bonds have traditionally returned considerably more, agrees Matthew Diczok, Fixed Income Strategist, Bank of America. But here's the thing: Few of us invest 20% or 30% of our gross income in the stock market every month.Footnote 2 The typical homeowner usually dedicates that much to their mortgage payment, and over the years those steady payments can really add up.
Graphic showing illustrations of a thumbs up and a thumbs down with copy that reads: Home Equity Do's and Don'ts — It can seem tempting to turn to your home's equity when you need cash. But there are some uses that don't make good financial sense. Here, Marie Imundo, senior Vice President of Mortgage Product Strategy, Global Wealth and Investment Management at Bank of America, gives her thumbs up — and down — on seven common uses.

Living in your biggest asset

"Your home might end up being the biggest asset on your balance sheet," Diczok says. For half of all 35- to 54-year-old couples, for example, home equity represents 51% or more of total net worth, according to U.S. Census Bureau data.Footnote 3 "That's why it's critical to look at how your home's value fits in with your other investments," he adds.
From an investing standpoint, that can mean a number of things. "Some people," Diczok says, "may feel comfortable taking on a little more risk in the way they approach the markets, knowing that they have a portion of their net worth invested in a relatively stable asset — their home." Others may see an advantage in being able to draw on their home equity to cover emergency expenses, rather than selling off shares in their portfolio. That way they don't miss out on any potential market growth. If the expense is large, however, taking out a home equity loan or line of credit could put your home at risk — if you can't pay off the loan you could lose your house.
There are three main ways to tap your home's value while you're still living there. The best choice for you will depend on interest rates and what you need the money for.
— Marie Imundo,
Senior Vice President of Mortgage Product Strategy,
Global Wealth and Investment Management at Bank of America

3 ways to tap your home equity

You don't have to sell your home, as I did, to put your equity to work for you of course. There are three main ways to tap your home's value while you're still living there, says Marie Imundo, Senior Vice President of Mortgage Product Strategy, Global Wealth and Investment Management at Bank of America. They are a home equity line of credit (better known as a HELOC), a home equity loan (sometimes referred to as a HELOAN) and a cash-out refinance. "The best choice for you will depend on interest rates and what you need the money for."
With a cash-out refinance, you get a new loan, ideally at a lower rate, to pay off your existing mortgage, plus some additional money from your home equity, which you might use to cover a home renovation project, or to help you manage any number of other current expenses. Cashing out your home equity is an option you might want to consider if you have a first mortgage on which you're paying a higher interest rate than is currently available. Keep in mind, though, says Imundo, that your new loan balance will be higher than your current loan, leaving you with a larger mortgage, typically a higher monthly payment (depending on available interest rates) and the potential to pay more interest over the life of the loan.
What if your current mortgage rate is already low? Then you may want to consider tapping into home equity through a home equity loan or a line of credit, Imundo says. The difference between the two? Home equity loans are for a fixed amount and are often made at fixed rates of interest. Home equity lines of credit give you access to a set amount of credit, but you don't have to use it all or all at the same time. You can tap that credit — and pay it off — as you need it during the "draw period," or the term of the loan. Home equity lines of credit are often made at variable rates of interest, though you can find fixed-rate options.
A home equity loan may make the most sense for a fixed expense — say college tuition that you might want to pay off over a number of years — while a home equity line of credit is generally used for recurring items, like home renovations, which may require frequent and varied withdrawal amounts.
One thing you should never consider using your home equity for, notes Imundo, is investing. Stocks, bonds and mutual funds fluctuate in value, and you wouldn't want to risk losing your home if the return on your investments is not sufficient to cover a new mortgage, loan or line of credit. If the value of your investments were to decrease, you might need to sell them to protect your home and limit further losses.

When the tuition bill comes due…

It's possible to tap your home equity to cover college tuition, which was the route chosen by one Merrill client. This client originally planned to cover college costs for his daughter by selling stocks, but doing so would have subjected him to capital gains taxes and forced him to reduce his stock holdings at a time when the market was appreciating rapidly. Instead, he used a home equity line of credit, or HELOC, to cover his daughter's $50,000 annual college tab.
Because the client intended to sell his home and downsize once his daughter graduated, the long-term impact of rising interest rates on the cost of a variable rate HELOC was not likely to be a significant consideration at that point in time.
Of course, another solution may be more appropriate for a different family. There are no one-size-fits-all answers in wealth management.

The hidden benefits of downsizing

Many retirees decide to downsize in retirement, and doing so comes with potential added benefits — you can cut many home-related expenses. CRR found that empty-nesters were spending 30% of their income on property taxes, insurance, maintenance and utilities.Footnote 4
The question for downsizers then becomes what to do with all of the unleashed capital. There's no single right answer, says Imundo. Solidifying your goals and reviewing all of the options can help you figure out what might work best for what you want to achieve.
In my case, I ended up finding a smaller house, with a smaller yard, but with lots of adult-friendly amenities. My misty-eyed son and his friends dried their tears quickly when they realized that my form of downsizing involved buying a house that came with a swimming pool and a pool table.
In fact, it's all worked out so well that I'm thinking of tapping my home equity and downsizing yet again — when I stop working. Next time, I'll use the funds to subsidize my yen for travel.
Kathy Kristof is an award-winning personal finance and investing journalist who writes frequently for a variety of major publications. She is the author of Investing 101 and Taming the Tuition Tiger. Find more of her reporting at KathyKristof.com.
Next steps

Footnote 1 Federal Housing Finance Agency, "U.S. House Prices Rise 1.4 Percent in First Quarter," 2017.

Footnote 2 Bloomberg, "Housing's 30-Percent-of-Income Rule is Nearly Useless," July 2014.

Footnote 3 U.S. Census Bureau, "Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2013," 2013.

Footnote 4 Center for Retirement Research at Boston College, "Is Home Equity an Underutilized Retirement Asset?" 2017.

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