What you need to know about home equity
Home equity can be confusing, so here are three simple ways to define this important part of homeownership.
Home Equity is:
- The market value of a property, minus any claims or liens against it.
- The percentage of your home that you actually own.
- The financial interest you have in a property.
For the majority of homeowners, it's usually not possible to purchase a home without borrowing a large chunk of the money. To take out a mortgage, you choose a lender and they loan you the money to buy the home. You're a homeowner — but, you have a partner: you and the mortgage company both have skin in the game until the entire loan is paid off. Only then will you end up owning the property free and clear!
Figuring out how much home equity you have
Let's imagine that you negotiated a purchase price of $250,000 for your dream home. You put up $50,000 as a down payment. To get the keys to the house, you still need to give the seller $200,000, which you're getting as a loan from a mortgage lender.
Use this formula to see your portion of the home's equity: Take your home's worth ($250,000) and divide it by your down payment ($50,000). You get 20%. That means you have 20% equity in the value of your property from the beginning of your homeownership. The lender holds the remaining 80% because they have $200,000 invested in the property.
Building equity a little at a time
As you repay your mortgage loan, you're gradually building equity in your home. Every time you make your monthly payment, a large chunk goes to paying down the interest on the amount borrowed and a small portion goes towards paying down the loan's balance — also known as the principal. As your loan balance decreases, your equity in the home increases.
Building equity a little faster
Equity also increases if your home value increases. That may be due to improvements made to your local economy, like opening a new park or revitalizing a downtown shopping district. Your home can benefit just by being a part of the neighborhood. Your home's value can also increase if you take on a home improvement project. For example, imagine you borrow $20,000 from your home equity to updo the kitchen and it increases the property value by $35,000. That renovation just boosted your home equity by $15,000.
How home equity can help your family
Even though it's tied up in your home, equity is considered a part of your net worth. It's an asset that you can tap into when you have a larger-than-normal expense that you need to make.
We already mentioned that you could borrow against your home equity to make home improvements. But did you also know you can borrow against it to purchase a second home, buy a new car, pay for a wedding, pay off student loans or cover college tuition for your kids? Or you could leave it where it is and watch it grow. It's up to you.
Three ways homeowners can tap into home equity
If you decide to leverage the equity you have built up in your home, you have several choices. Each is based on the total equity built up so far, your credit score and your history of making monthly payments.
Let's look at the most popular.
- Cash-Out Refi: With a cash-out refinance, the homeowner can borrow a portion of the home equity they've built up and refinance their home loan at the same time. Just make sure that the current interest rate is lower than the rate applied to your original mortgage.
- Home Equity Line Of Credit: Also known as a HELOC, this is a revolving credit line with a variable interest rate. Like a credit card, it allows you to repeatedly withdraw and repay funds (plus interest) as often as you need to.
- Home Equity Loan: Homeowners can use a home equity loan to get a lump sum of cash that will need to be paid back within a term agreed to by their lender. What's nice about a Home Equity Loan is that you get fixed, predictable interest payments over the length of the loan.
Keep in mind that most lenders won't let you borrow against the total amount of your home equity. Typically, borrowers with perfect payment histories and good credit scores can borrow up as much as 80% of the homeowner's available equity.
Take pride in your home – and your home equity
Homeownership is something to be proud of! And home equity is a powerful tool that should be handled carefully. It's important to ask questions to fully understand your options. Reach out to speak with a Movement Mortgage professional near you. Or, if you're ready to get started, apply online.
