What you need to know about home equity
We’re going to let you in on a little secret: one of the best ways to build wealth can be through the purchase of a home. (This might not actually be a secret, but we wanted to tell you anyway.)
But why is this such a good way to build wealth? It’s because of something called home equity. This can help you build wealth over time AND may open up opportunities to leverage that equity to accomplish goals in the future.
Let’s break down the ins and outs of home equity and how you can use it to help improve your financial situation.
Defining home equity
Understanding 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.
Figuring out how much home equity you have*
Let's imagine that you negotiated a purchase price of $450,000 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 $400,000, 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 ($450,000) and divide it by your down payment ($50,000). You get 11%. That means you have 11% equity in the value of your property from the beginning of your homeownership. The lender holds the remaining 89% because they have $400,000 invested in the property.
*For example purposes only. Additional costs and fees may apply. Reach out to a loan officer for your specific situation.
Building equity a little at a time
Your home equity can build over time in a few different ways. First, make sure you choose the right mortgage type. Avoiding an interest-only loan, where no principal is paid off until a single lump sum is paid, can help you build equity consistently.
As you repay your mortgage loan, you're also 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.
You can also make it a habit to pay every mortgage payment on time. And, if you’re able to, try paying more than the minimum amount required to help shorten the life of your loan.
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 update the kitchen and it increases the property value by $35,000. That renovation just boosted your home equity by $15,000.* But make sure to do your research beforehand because not all changes will boost your home’s value.
*Data is hypothetical. Reach out to a loan officer for your specific situation.
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: A cash-out refinance involves using your equity to get a new mortgage that’s larger than the amount owed on your existing mortgage. After you pay off your existing mortgage, you can then use the remaining money* however you choose. Basically, this allows qualified borrowers to borrow some of your home’s equity and refinance your home loan at the same time. (Pro tip: Just make sure that the current interest rate is lower than the rate applied to your original mortgage.)
*By refinancing your existing loan, your total finance charges may be higher over the life of the loan.
- Home Equity Line Of Credit: Also known as a HELOC, this is a revolving credit line with an adjustable interest rate. Qualified borrowers can borrow up to a certain amount over a period of time. Think of it like your credit card: you can continually borrow money up to an approved limit, but you also need to pay off the balance as you go.
- Home Equity Loan: Qualified homeowners can use a home equity loan (also known as a second mortgage) to borrow a lump sum against their current home equity for a fixed rate. The loan must then be paid back within a term agreed to by the 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 can help you achieve your goals. It's important to ask questions to fully understand your options.
Reach out to a Movement loan officer near you today for more information!
