Make rising home value work for you

Your Money
Sandra Block
USA Today

Your home may not look like a castle, but if you live in a hot real estate market, people will pay a king's ransom to buy it.

Consider, for example, the lucky denizens of Las Vegas. The median home price in that metropolitan area rose 47% in the fourth quarter from a year earlier, according to the National Association of Realtors. A record 62 metro areas reported double-digit increases during the fourth quarter.

For folks who bought their homes before the boom, this is heady stuff. But short of selling and moving to Beaumont, Texas — where the median home price is $87,800 — how do you take advantage of your home equity? Some ideas:

Torpedo PMI. Home buyers who put less than 20% down on their mortgage typically have to pay private mortgage insurance. Under the federal Homeowner's Protection Act, your lender must cancel PMI when your equity reaches 22% of the original value of your home. The law applies only to loans made on or after July 29, 1999. And because automatic termination is tied to the original value of your home, not its current market value, reaching the threshold can take years.

However, if your home has appreciated in value, you may be able to jettison PMI sooner. Here's how:

• If you've lived in your home for at least two years and your home value has increased, ask your lender to cancel your PMI. Your lender probably will require an appraisal, and you'll have to pay for it, says Keith Gumbinger, vice president of HSH Associates, a consulting firm. Even after the appraisal, there's no guarantee your lender will agree to scuttle PMI.

• Refinance your mortgage. When you refinance, your home will be appraised. If your new loan makes up less than 80% of your home's value, you can say goodbye to PMI. Mortgage rates are still at historic lows, so you should be able to refinance for the same rate you're paying now, says Bob Walters, chief economist for Quicken Loans. But by eliminating PMI, you can reduce your payments by hundreds of dollars a year, he says.

Shift into reverse. The real estate boom has created a quandary for many older homeowners: Their home may be worth $1 million, but they can't afford to buy groceries.

One solution is to downsize, but many senior citizens don't want to move. For those homeowners, an increasingly popular option is a reverse mortgage.

A reverse mortgage allows senior citizens to earn tax-free income by tapping the equity in their homes. The loan doesn't have to be repaid until the homeowner moves, sells the house or dies.

You must be at least 62 to qualify for a reverse mortgage, and if the home is jointly owned, both owners must be at least 62. Lenders base the size of the loan on three factors — the age of the borrower, current interest rates and the value of the home — says James Mahoney, chief executive of Financial Freedom, one of the nation's largest providers of reverse mortgages.

Because interest rates are low and home values are high, now is an ideal time to consider a reverse mortgage, Mahoney says. You can arrange for monthly payments, a lump sum, a line of credit or a combination.

The maximum loan limit for a federally insured Home Equity Conversion Mortgage, which accounts for about 90% of reverse mortgages, is $312,896. Financial Freedom also offers a "jumbo" product for qualified homeowners who want to borrow more.

If you think you might move in a year or two, a reverse mortgage probably isn't a good idea. Upfront costs, which are similar to those for a traditional mortgage, can be steep. While those costs will be rolled into the balance, it doesn't make sense to pay them for a short-term loan.

For more information about reverse mortgages, check out the AARP's Web site, www.aarp.org/revmort. For a list of lenders, go to www.reversemortgage.org.

Retire high-cost debt. This is probably the most popular use for home equity, and at today's rates, it's still smart. The average interest rate on a home equity line of credit is 5.79%, vs. 13.4% for a variable-rate credit card, according to Bankrate.com. Rates on home equity lines are variable, so the interest rate could increase. But borrowing from your home remains "the cheapest form of financing you can get," Walters says.

There are lots of other ways you can spend your equity: Buy a second home, for example, or update your kitchen. But don't get carried away. Home prices have been known to decline. If that happens, your equity will provide a much-needed cushion. And an unused line of credit can provide low-cost financing in an emergency.

"Home equity is your hole card," says Phillip Cook, a financial planner in Torrance, Calif. "Don't do anything stupid with that asset."