What Is Home Equity?
Home equity is the value of your home that you actually own. It’s the part of your property that you’ve paid off in comparison to what you still owe.
For example, if your home’s current market value is $300,000 and your remaining mortgage balance is $150,000, your home equity is $150,000. It’s that simple.
When starting with a new home, your home equity is equal to your down payment. As you pay off your mortgage over time, you steadily increase your equity.
How Does Home Equity Work?
Are you wondering how home equity works? It’s pretty straightforward.
Here’s the process:
- You Purchase a House: When you buy a house, you make a down payment and borrow the rest of the money through a loan, typically a mortgage.
- You Pay Down Your Mortgage: Over time, you pay down your mortgage. Every dollar you put toward your mortgage increases your equity.
- Your Home’s Value Can Increase or Decrease: Real estate values fluctuate. If your home’s value increases, your equity does too.
Remember: Your home equity isn’t a fixed number — it can change. Your equity can increase as you pay down your mortgage or if your home’s value goes up. If your home’s value goes down, however, your equity can decrease.
How To Build Home Equity
Building home equity may sound complicated, but it doesn’t have to be. Here are a few strategies that can help:
Make A Big Down Payment
The size of your down payment determines your home equity at the purchase point. So making a bigger down payment means starting with a larger chunk of equity.
Focus On Paying Off Your Mortgage
When you start reducing your mortgage balance, you’re actually building equity. Imagine your home’s value stays the same — each mortgage payment decreases the amount you owe and increases your equity.
Pay More Than The Minimum
Paying more than the minimum mortgage payment can help increase your equity faster. Extra payments are used to reduce your mortgage balance, not your interest, allowing you to build equity sooner.
Stay In Your Home 5 Years Or More
Staying in your home for the long-term can significantly help build your home equity. Remember, the longer you pay your mortgage, the more your equity increases. Plus, home values historically tend to appreciate over time. Homeowners who stay in their property for 5 years or more will generally see an increase in their home equity, even if due only to inflation.
Renovate And Add Curb Appeal
Besides paying down your mortgage, another way to increase your home equity is to increase your home’s value. Renovations and improvements can often increase a home’s market value. Adding curb appeal can attract potential buyers and possibly drive up your home’s selling price, thus boosting your equity.
How To Use Home Equity
Home equity is a powerful financial tool that grows over time. How you use this equity can have a significant impact on your financial health. Here are some popular ways to use home equity:
Using Equity To Buy A New Home
One of the more common uses of home equity is utilizing it for a down payment on a new property.
- Selling Your Home: If you’re looking to move, you could sell your current home, take the equity you’ve built, and apply it to your new home purchase. This strategy may significantly lower the amount you have to finance for the new property and could have potential tax benefits.
- Renting Your Home: Alternatively, you might decide to rent out your current home. This could provide you with a regular source of income, and you could use the home equity to secure a home equity loan or line of credit to finance your new home.
Using Equity For Your Retirement
As retirement approaches, many homeowners start considering how to use their home equity to secure a comfortable life.
- Downsizing: If your current property is larger than what you need, it might make sense to sell and downsize to a smaller, more manageable home. The difference between the selling price and the cost of your new home can add a significant sum to your retirement savings.
- Reverse Mortgage: A reverse mortgage can be a useful tool for accessing the equity in your home without selling. Essentially, you will be borrowing against the value of your home, receiving money as a lump sum, line of credit, or regular payments. This loan does not require monthly mortgage payments and is repaid when the homeowner sells the home, moves out permanently, or passes away.
When considering a reverse mortgage, it’s essential to understand the cost and risks. Consulting with a financial advisor can provide valuable insight into whether this option fits your financial situation.
- Renting Out Your Home: Perhaps your retirement plans include extensive travel or living in a different location. In this case, renting out your current home might be a strong option. Renting could provide a steady income stream during your retirement without the need to sell or take out a loan.
Options For Borrowing Against Home Equity
Once you’ve built up some home equity, you might consider borrowing against it. This decision shouldn’t be made lightly, as it can put your home at risk if you fail to repay the debt. However, it can be a viable option for financing large expenses. Here are a couple of ways to borrow against your home equity:
Cash-Out Refinance
A cash-out refinance allows you to refinance your mortgage for more than you owe and take the difference in cash. The new loan will be larger, but you will get access to immediate cash and likely a new lower interest rate.
Home Equity Loan
A Home Equity Loan, a.k.a., “second mortgage,” allows you to borrow a lump sum against your home’s equity at a fixed interest rate. You then repay the loan in fixed monthly payments over a specified term.
Home Equity Line Of Credit
A Home Equity Line Of Credit (HELOC) is similar to a credit card: the lender sets a maximum borrowing limit, and you can draw out money as you need it. You only pay interest on the amount you’ve borrowed, not the full credit line.
Like a Home Equity Loan, a HELOC uses your home as collateral. But unlike a Home Equity Loan, the interest rate on a HELOC is usually variable, so your payments could change over time.
Home Equity FAQs
How does equity in a home work?
In the simplest terms, home equity is the portion of your home that you truly ‘own.’ You gain home equity as you pay down your mortgage – the difference between your home’s market value and your remaining mortgage balance is your home equity.
Is it a good idea to take equity out of your house?
Utilizing home equity can be a good idea depending upon the circumstances. If you have significant expenses such as college tuition, home renovations, or high-interest debts, a home equity loan can be an affordable way to cover these costs. But remember, your home is collateral, meaning if you can’t repay the loan, you could potentially lose your home.
What is equity in a home for dummies?
To explain equity in a home for dummies, think about a jar of cookies. The total number of cookies in the jar is like the value of your home. Each time you make a mortgage payment, you’re taking a cookie out of the “debt” jar and placing it in your “equity” jar. After a while, you will have more cookies in your “equity” jar than the “debt” jar – that’s when you fully own your house.
Can you take equity out of your house without refinancing?
Yes, you can use a home equity loan or a home equity line of credit (HELOC) to take equity out of your house without refinancing. Alternatively, a cash-out refinance is another method where your house is refinanced for more than you owe, and you get the difference in cash.
ss begins which includes signing official paperwork as well as settling any fees or costs. With each financial decision, you must respect the potential risks involved. Therefore, it’s crucial to understand the full implications before borrowing against your home equity.
