If you’re wondering what you need to know about home equity, read on to learn about its overall importance and how to use it to afford a new home or pay for some of life’s larger expenses.
What Is Equity?
Home equity refers to the amount of a home’s value that you actually own. Yes, your signature may be scribbled on the deed, but until you’ve paid off the entire mortgage, you technically own only a share of the home’s value.
Ultimately, home equity is the difference between your home’s fair market value and the amount you still owe to your lender.
For example, let’s say that the home you purchased was $200,000. You made a 5% down payment ($10,000), and then a mortgage company financed the rest. This means that you’ve got $10,000 in equity – or 5% in equity interest.
With each mortgage payment, a portion of that money goes toward paying for the home itself (which increases your equity), and a portion goes toward paying the interest. As you pay down the amount on your loan, more money will go toward building equity and less will go toward the interest. If you want to know more about this process, check out this article on mortgage amortization.
One confusing part of equity is that it’s always changing. There are two variables to consider: the appraised value of the home and the loan balance.
For instance, let’s say you purchased a house in 2010 that had an appraised value of $200,000. You purchased the home with a $10,000 down payment (your loan balance is $190,000), meaning you have 5% equity.
Fast-forward five years, and suddenly, the value of your home has dropped. Now your house appraises for $198,000. But you’ve still been paying down your loan, so you only owe $181,000. This means that you have 8.5% equity ($17,000) in your home.
Fast-forward another two years, and now your home has an appraised value of $202,000, and you have a loan balance of $177,000. Now your equity has risen to 12% ($25,000).
In the end, what you owe on the house is more important than what you’ve paid. It’s important to note that a change in equity won’t change the loan amount. Whether your home’s value goes up or down, you will still need to pay the original amount of the loan, plus interest.
Should I Buy or Rent?
When deciding whether to buy or rent a home, you should start by considering equity. If you own a home, you will generally gain equity each month. After all, a portion of your monthly mortgage payment goes toward paying off the house (which builds equity).
When you live in an apartment, your monthly rent isn’t gaining you anything. Because owning a home allows you to build equity, having a mortgage is sometimes called “forced savings.”
How Long Does It Take to Earn Equity in Your Home?
According to Professor of Law and Research Director at the Center for Urban Business Entrepreneurship David Reiss, “You start earning equity on your home as soon as you purchase it because part of our mortgage payment goes toward repaying the principal that you borrowed. The repaid principal adds to your equity in your home.”
Ultimately, Reiss claims that as your home value rises, you build additional equity.
Why Is Equity Important to Me?
Equity is a great example of an asset. In the event that you need it, you can use that money for future endeavors, such as buying a new home, paying for an important life event or even helping to fund your retirement.
Using Equity for a New Home
Let’s say after eight years of living in your home, you’re beginning a new career, starting a family or even just looking for a change of scenery. Whatever the reason, you’re ready to pack up and head to a new home.
If you’re selling a house that’s worth $200,000 and you have $60,000 in home equity, for example, you could use that money for your new home’s down payment. And because you’ll have such a large down payment, your monthly mortgage payment will then be lower than it was on your old home.
Take Advantage of a Cash-Out Refinance
While some lenders may offer a home equity line of credit (HELOC) or a home equity loan, at Quicken Loans, we offer a cash-out refinance. In this type of refinance, you take the equity you’ve earned and turn it into cash.
For example, if your mortgage balance is $150,000 and your home is worth $200,000, you may be able to refinance for $175,000, which would allow you to pull out $25,000 in cash. You could use that extra cash to pay off high-interest debt, tackle home improvement projects or finance a major purchase.
Using Equity for Your Retirement
If you’re over 62 and looking to retire, you could also consider a reverse mortgage. This is an option that allows you to stop making mortgage payments and pull from the equity that you already have on the house. In other words, you can use the value you’ve accrued in your home to help fund your retirement.
Still have questions about equity? Feel free to ask them below! And if you’re ready to make your equity work for you, speak with a Home Loan Expert today!
If so, subscribe now for tips on home, money, and life delivered straight to your inbox.