One of the main benefits of owning a home is increasing the equity in your home. But what is home equity and why is it important? We’ll show you how to calculate your home equity and explain why having it can be beneficial to you.
What is home equity?
Your home equity refers to the amount of your home that you own in full. Most people who buy a home don’t pay all of a sudden. Rather, they make a down payment and finance the rest with a mortgage. The equity in your home is the difference between what you owe on your home and its current value.
When you first buy a home, you might not have a lot of equity, but over time your equity can increase. That’s because when you pay off your mortgage principal, you own more of your home.
In addition, property values tend to increase over time. If you buy your home for $ 300,000, but over the years its value rises to $ 400,000, you will gain a lot more equity.
How to calculate home equity
Calculating home equity is pretty straightforward:
- Take the current value of your home (at which it would sell today).
- Subtract your remaining mortgage balance.
- The result is the amount of equity you have.
Suppose your house is currently worth $ 300,000 and you owe $ 240,000 on your mortgage. You have $ 60,000 left in equity in your home. Home equity can also be expressed as a percentage. In this case, that $ 60,000 out of $ 300,000 means you have 20% of the equity in your home.
What Can Home Equity Do For You?
Not only can you use the equity in your home if you are buying a new home, but you can also borrow against the equity in your property.
Imagine that you are looking to expand your home and have $ 100,000 of equity in your current property. If you sell that house and take that $ 100,000 in profit, you could use that money as a down payment on a new home.
You can also use the equity in your home to borrow against your home. You have two options: a home equity loan or a home equity line of credit (HELOC).
Home equity loans
With a home equity loan, you borrow a lump sum of cash and pay it back over time. The advantage of a home equity loan is that you usually get a lower interest rate than other types of loans. Plus, you often get approved for a home equity loan even if your credit rating isn’t great.
The reason? With a home equity loan, your home itself is collateral to secure the loan. A lender who gives you a home equity loan takes limited risk because if you don’t make your payments, that lender could eventually force your home to be foreclosed and get the money it’s owed. This is why a home equity loan is considered a “second mortgage”.
This speaks to the danger of a home equity loan. If you are late with your payments, you risk losing your home. But a home equity loan should come with a fixed interest rate, so your monthly payments are predictable. It might make them more manageable.
Many homeowners use home equity loans to improve their properties, but you can use them for any purpose. You can use the proceeds to pay off other debts or cover your children’s education costs if you wish.
Home Equity Lines of Credit (HELOC)
With a HELOC, you don’t borrow a lump sum. Rather, you get approved for a line of credit based on the equity in your home. You can draw on this line of credit as needed within a predefined time frame – typically five to 10 years. You are only charged interest on the portion of this line of credit that you access.
As is the case with a home equity loan, you can take out a HELOC for any purpose. But in the context of home renovations, a HELOC can be a smart choice. Home renovations can be hard to budget for. By accessing a line of credit rather than committing to borrowing a set amount, you give yourself more flexibility.
Like home equity loans, HELOCs are secured by the properties to which they are linked, so if you fall behind on your HELOC payments, you risk losing your home. Additionally, HELOCs tend to carry variable interest rates, so your monthly HELOC payments may change over time. But it’s also pretty easy to qualify for HELOCs if you have equity in your home and typically pay less interest on a HELOC than on other types of loans that don’t relate to your property.
Refinancing of withdrawals
With withdrawal refinancing, you borrow more than your loan balance and get the rest in cash to use as you wish. If you owe $ 200,000 on your mortgage, but your home is worth $ 300,000 and you want to borrow $ 20,000 to start a business, you can use the equity in your home to take out a new loan of $ 220,000. . The first $ 200,000 pays off your existing loan, and the rest of that money comes back to you.
How to increase home equity
There are different steps you can take to increase the amount of equity in your home.
1. Pay a higher deposit at closing
Most mortgage lenders require a 10% or more down payment on closing, although your lender may want more or less. It’s usually a good idea to pay at least 20% of the purchase price of your home when you finalize your mortgage, as this allows you to avoid private mortgage insurance, an expensive premium that makes owning your home more expensive.
But depositing at least 20% also gives you more instant equity in your home. And the higher the down payment you make, the more equity you have.
2. Make more than your minimum monthly payment
You are generally allowed to put extra money into your mortgage each month. If you increase your mortgage payments, you pay off your loan principal faster and build equity faster.
You can also make lump sum payments on your mortgage within your means. If you get a tax refund or a work premium, for example, and give that money to your lender rather than spending it, you’ll build up more equity sooner.
3. Improve your home
The more your home is worth, the more equity you can earn. By renovating your property or making certain types of improvements, you can increase the value of your property, which in turn can give you more equity.
4. Stay longer at home
Home values don’t always increase over time, but they often do. Staying in your home for many years could increase your home equity.
The net result on the equity of a home
Home equity is a valuable financial tool that you can use to your advantage. And the best part? As your home increases in value, you gain financial freedom without having to do anything.