Home Equity: Do You Need It?
Home equity is a term that’s thrown around a lot, but do you know what it really means for you and your financial outlook?
Home equity is an asset, possibly one of the most valuable assets you’ll have in your lifetime. There might come a day you want to be able to use that asset for a second mortgage or home equity loan, so it’s critical you understand what it is and isn’t.
On the most basic level, home equity is the portion of your home value that you own. If you took out a loan to buy your property, it’s the difference between the home’s fair market value minus the outstanding balances of all loans or liens on the property. Home equity is something that builds over time and can be used in a variety of ways. Let’s take a look at home equity and what it means for you.
Your Home Equity
Let’s use an example to make home equity clear. Let’s say you bought your house for $400,000 and put down $80,000, securing a loan for the rest of the amount. On day one, your home equity is $80,000, or 20 percent.
Your lender never owns the other portion — you own the house. Instead, the house is collateral for your loan.
How Can You Build Home Equity?
Over time, as you make monthly payments on your loan, you increase your home equity. The majority of home loans in the United States are standard amortizing loans. This means you make a flat monthly payment that goes toward both your interest and principal. Through the years, the percentage applied to the principal repayment gets larger. This means you build equity at an increasing rate each year. That’s great news!
You can also build home equity if your home increases in value. The amount you owe on your loan stays the same, but the fair market value of your property is greater.
Increase Your Property Value
Without having to do anything, you may see an increase in property value from a healthy market or a positive change in your neighborhood. This is the easiest way to increase your home equity.
Another way is through home improvements and making an investment in your property that will increase its value. This could be anything from a kitchen renovation to updating the curb appeal through landscaping. You’ll want to do some research on which home improvement projects offer the biggest return on investment (ROI), because you’ll have upfront costs associated with any renovations.
Be sure you maintain your property because problems like foundation issues or a leaking roof can actually decrease your home’s property value, and therefore your home equity.
Decrease Your Debt
Consider making extra payments on your mortgage each month or from time to time to pay down your loan faster. Just make sure your lender is applying the extra money toward your loan’s principal, not interest. You’ll be surprised how quickly this extra can add up and increase your home equity.
Using Your Home Equity
Like we said above, your home equity is an asset. There are many ways you can spend it, or you can choose to leave it to your heirs.
Commonly, people use their home equity when they decide to buy another house. You can put the equity you’ve built up toward the purchase, meaning you’ll have to borrow less.
Some people choose to borrow against their home equity with a loan, which is known as a second mortgage. This can be used to fund things like home improvement projects, college tuition or to cover an unexpected expense like medical bills.
Home Equity Loans
Home equity loans allow homeowners to borrow against the value they’ve built up in their home. They come in two varieties, the first of which is a lump-sum loan repaid with a flat monthly fee over a fixed period of time. The interest rates on home equity loans are usually fixed.
The second is a home equity line of credit, similar to a credit card. You have a line of credit to access as needed during the “draw” period, making smaller monthly payments during this time. Once that “draw” period is up, say after five years, you’ll enter the repayment period, which usually features bigger monthly payments. The interest rates on home equity lines of credit are typically variable.
Home equity loans are appealing because they usually have lower interest rates, allow homeowners to qualify for larger loans, are easier to qualify for (especially if you have bad credit) and the interest paid might be tax deductible.
Home equity is an important part of your total net worth and understanding what it is can make it work for you. Once you understand the importance of home equity, you will be equipped to sell your home or buy a new home by making educated decisions. And if you’re wanting to save as much money as you can throughout the buying or selling process, ForSaleByOwner can help you find success without incurring the costs associated with using an agent.