Escape from Mortgage Madness: A Common Sense Approach to Home Equity

By Richard Barrington
LoanPage.com Columnist

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It's been an ugly year for the mortgage industry, and home equity loans are among the culprits being cited by the media for the upswing in foreclosures.

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However, a little common sense, a little discipline, plus some help from a freely-available tool such as a mortgage calculator, can help you use your home equity effectively and safely. The common sense can be boiled down to two rules: don't confuse equity with liquidity, and differentiate between spending and investment. For starters, let's look at the first rule.

Don't Confuse Equity with Liquidity

Through a combination of years of mortgage payments and real estate appreciation, you may have built up an impressive amount of home equity. However, having that equity is not the same thing as having the liquidity to pay off a loan against it.

Think of liquidity as ready cash--for example, the money you'd need to make the monthly payments on a mortgage. In other words, be sure to borrow only to the extent of your liquidity, not to the extent of your equity.

Calculate Before You Commit

By way of illustration, a couple with $100,000 in home equity would theoretically be able to borrow against that amount. However, running that amount through a mortgage calculator, say for 15 years at 5.9%, shows they would be facing a monthly payment on this new loan of $838.

It is this $838 that is the crucial figure. Unless the homeowners can come up with this much extra cash each and every month, they won't have the liquidity to pay off the loan. This could lead to foreclosure, even though they theoretically have equity in excess of what they owe. A little common sense, with the help of a mortgage calculator, can help avoid a lot of trouble.

Sources
Bloomberg.com
Yahoo! Real Estate

About the Author
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.

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