Your home is probably one of the most valuable assets you’ll ever have. There might come a day when you want to use that asset to obtain a second mortgage or a home equity loan, so it’s important to understand what home equity is and how you can use it.
What Is Home Equity
Home equity is the amount of your property that you actually own. If you took out a loan to buy your property, home equity would be the difference between the home’s fair market value minus the outstanding balances of all loans or liens on the property.
Here’s an example: Let’s say you bought your house for $400,000, put down $80,000 as a down payment and secured a loan for the rest of the amount. On day one, your home equity is 20%.
Your lender never owns the other portion — you own the house. Instead, the house is collateral for your loan.
Why Is Your Home Equity Important?
Building equity in a home is important because a home is often a person’s biggest asset and source of wealth. Because it’s considered an asset, you can use the equity you’ve built in your home for different purposes – remodeling, paying for a child or grandchild’s education or adding to your retirement, to name a few.
How Can You Build Home Equity?
Home equity is something that builds over time and can be used in a variety of ways.
There are two ways to grow your home equity: pay down your principal loan balance and increase your home’s market value.
Over time, as you make monthly payments on your loan, you increase your home equity. That’s why some refer to a monthly house payment as a “forced savings account.”
If home prices in your area are rising, you will also see an increase in your home’s equity because your home’s value is now higher. But keep in mind, home equity is not guaranteed and typically, building equity takes time.
Tips For Building Home Equity
Make More Or Larger Mortgage Payments
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 money can add up and increase your home equity.
Here are some ideas on how to do this, depending on your financial situation and goals:
- Pay down your mortgage with two payments a month rather than one.
- Schedule extra payments at certain intervals – such as quarterly or semiannually.
- Round up payments.
- Add an extra lump sum to your regular monthly payment.
Make A Large Down Payment
If you’re ready to move into a new home, consider making a large down payment. This sets you up with more equity in your home right off the bat. It will also lower your monthly payments a bit – bonus! If you put more than 20% down, you’ll also avoid private mortgage insurance.
Make Smart Home improvements
Some home improvement projects are worth the investment, and others aren’t. Here are some that could help you increase the value of your home.
Almost everybody loves a nice kitchen! A kitchen remodel can add value to your home, but be careful not to go overboard. Your kitchen shouldn’t be fancier than the rest of the house. Check out these tips on how to use your kitchen to draw in buyers.
Fix Problem Areas
Every house has them. That leaky faucet. The old front door with the chipped paint. Don’t let these defects hurt your home’s value. Follow these tips on how to fix your home’s problem areas.
The first thing people notice about your house is the outside. How is your curb appeal? If you aren’t sure or need some tips on where to start improving, check out our advice on how to improve your home’s curb appeal.
Renovating your home isn’t a walk in the park, but the return can mean more equity for you. To help you decide if you should make home improvements to help increase your home’s equity, check out our blog on how to maximize your home’s value with renovations.
What Can Home Equity Do For You?
Home equity is an asset. You can choose to leave it to your heirs or spend it in many ways.
Use Equity To Help You Buy Another Home
Oftentimes, 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.
Equity Allows You To Take Out A Second Mortgage
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 and college tuition or to cover an unexpected expense like medical bills.
What Are 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 and make smaller monthly payments during this time. Once that “draw” period is up, say after five years, you’ll enter the repayment period, which usually requires 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 and are easier to qualify for (especially if you have bad credit), and the interest paid might be tax deductible.
The Bottom Line
Home equity is an important part of your total net worth, and understanding what it is can benefit you now and in the future. Once you understand the importance of home equity, you will be equipped to make educated decisions about whether to sell your home or buy a new home.
If you want to save as much money as you can throughout the buying or selling process, we can help you find success without incurring the costs associated with using an agent. Visit www.forsalebyowner.comto get started today.