Understanding home equity can seem rather tricky at first, but if you have a mortgage, it is important to comprehend exactly what home equity is. No matter how you look at it, if you are paying off a loan on your property, the home equity of the property is your money. Most homeowners do not fully use the power of their equity, mainly because they do not understand it.
You therefore need to know more about what it is and how it can be used so you can take full advantage of this homeowner resource.
Use the following information to learn how you can build your home equity over time, how you can use your home equity for different purposes and how you can take out a home equity loan. Once you understand the different aspects of home equity, you will be in a good position to know what to do with your equity and how to best use it to your advantage.
About Home Equity
Home equity is an asset that comes from the interest of your home. It is the market value of your property with the amount you owe deducted. Simply put, home equity is the portion of your home that you actually own as you are paying off the loan on your property. If the value of your property increases or your loan’s balance decreases, your home equity can go up.
If you are still unclear as to what that actually means, here is an example. If you buy a house worth $400,000, you may pay $20,000 as a 5 percent down payment and borrow the remaining $380,000.
You will then have home equity of $20,000, as this is the amount that has already been paid outright. As you pay off your mortgage with monthly payments over the years, the amount you owe will decrease and the amount of your home equity will increase.
If the value of your property goes up, your home equity will also increase. For example, if the house you bought five years ago for $400,000 is worth $500,000 today, and you have paid $50,000 toward your mortgage of $380,000, you will owe the remainder of $330,000.
Therefore, the difference between that figure and the new value of the home is your home equity amount. Subtract $330,000 from the new market value of $500,000 to find your home equity amount of $170,000.
Building equity can be a great way of increasing your wealth over time if you are strategic. However, be aware that the value of a property can go down as well. If your home’s worth declines due to factors like an economic recession, your home equity amount will decrease.
It can even become negative if the value of your home decreases beyond what you owe.
Building Your Equity
How can you increase your home equity? Simply paying off your mortgage on time each month is the quickest and easiest way to build your home equity. You can also build equity by doing nothing, as long as the value of your home increases. The more your property goes up in value, the more your equity will increase.
If you are strategic, you can use the real estate market to your advantage. You could buy a home in an area with property that looks set to rise in value quickly. For instance, you may be able to buy a home for a reasonable price in an area that is being redeveloped. As long as the redevelopment goes according to plan and attracts many new residents and businesses to the area, your home’s worth is likely to go up.
You can then sell your home in order to realize a high level of equity from the property. However, there are no guarantees, so you should understand the real estate market well if you plan to make money out of your property in the long-term. Remember, prices can go down as well as up.
Using Your Home Equity
You can use your home equity in several ways. First, you may simply wish to let the amount build up over time and eventually sell your home for a profit. You may also wish to have some equity released, or you may want to use it strategically. Here are some ways you can make the most of your home equity:
- You can borrow against your home equity.
- You can buy a new home by selling your present property and putting the money towards the cost of a new home.
- You can use your home equity to fund your retirement.
- You can save the home equity and pass on the money to an heir.
Home Equity Loans
If you are in need of funds and attempting to save money at home is not enough, you may consider making use of your home equity by applying for a home equity loan. After all, it gives you the opportunity to get your hands on a substantial amount in funds. Home equity loans also often have low interest rates and are relatively easy to qualify for. This is because the home equity loan is secured by your property. However, you need to carefully consider whether a home equity loan is best for you and understand exactly how the loans work.
There are two types of home equity loans. There is a traditional home equity loan, where the interest rate remains fixed, and there is a home equity line of credit, which comes with an adjustable interest rate and can be used to pay for home improvement projects or anything else you wish to pay for. The terms of a home equity loan mean your lender will convert the amount of equity into a lump sum of money. With a home equity loan, you are essentially taking out a second mortgage.
There are risks involved with taking out a home equity loan, so you need to weigh up the pros and cons. The largest risk of using your home equity is the fact that your property is collateral for the loan. Therefore, if you are unable to repay the loan, you could lose your home because lenders can force foreclosure in order to get their money back.
Unexpected events can happen, such as losing your job or having a long-term illness that leaves you with large medical bills to pay. Therefore, you should make sure you are able to repay a home equity loan by factoring in unexpected occurrences and costs.
To obtain a home equity loan, you will need to apply to lenders in the same way as you would with any loan. Lenders, such as banks and private companies, evaluate the market value of your property and offer you a maximum amount that can be borrowed. Typically, lenders’ loan limits are 80 percent or less of your property’s market value.