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You’ve probably heard that one of the benefits of owning a home is that you can build equity in it, and that you can tap that equity to pay for a major kitchen remodel, eliminate your high interest rate credit card debt or even help cover your children’s college tuition.

But what exactly is equity and how can you use it? Here’s a quick guide to the basics of how home equity works and why it’s so valuable.

What is Equity?

Equity is the difference between what you owe on your mortgage and what your home is currently worth. If you owe $150,000 on your mortgage loan and your home is worth $200,000, you have $50,000 of equity in your home.

Your equity can increase in two ways. As you pay down your mortgage, the amount of equity in your home will rise. Your equity will also increase if the value of your home jumps.

Your equity can fall, too, if your home’s value drops at a rate faster than the speed at which you are paying down your mortgage’s principal balance.

How Equity Works

Here’s an example of how equity can change over time. Say you buy a house for $200,000. You might come up with a down payment of 10% of your home’s purchase price, $20,000. Your lender will then provide you with a mortgage loan of $180,000.

If your home is worth that $200,000 sales price, you now have $20,000 of equity, or $200,000 minus $180,000.

Jump ahead two years. You’ve been making your mortgage payments on time, and you might now owe $170,000 on your mortgage. Maybe your home’s value has jumped, too, during this time to $210,000. You now have $40,000 in equity, or $210,000 minus $170,000.

Your home’s value could work against you, too. Say you’ve paid down your mortgage loan to that same $170,000, but your home’s value has actually dipped to $195,000. Now you have $25,000 in equity, or $195,000 minus $170,000.

To determine your equity at any one time, you’ll need to know the value of your home. Only a real estate appraiser can give your home an official valuation of what your home is worth in today’s market. You can, though, estimate your home’s value by looking at comparable home sales in your area or by checking with online real estate sales that provide their own home value estimates. Just remember that these estimates aren’t always accurate and exist just to give you a rough idea of your home’s current worth.

How to Build Equity

Fortunately, there are a number of ways to build equity in your home.

Make a Big Down Payment

The fastest way to build equity is to come up with a large down payment. The bigger your down payment, the more equity you’ll immediately have in your home. Say you buy your home for $180,000. If you put down $5,000, you’ll owe $175,000 on your mortgage. That leaves you with $5,000 in equity. If you put down $20,000, you’ll owe $160,000 on a home worth $180,000. That’s a far more impressive $20,000 in equity.

Focus on Paying Off Your Mortgage

A portion of each mortgage payment you make will go toward paying down the principal balance of your home loan. The rest will usually go toward paying interest, property taxes and homeowners insurance. When you first start making your mortgage payments, a smaller amount will go toward reducing your principal balance and more of your dollars will go toward paying down your interest. The good news, though, is that the longer you have your mortgage, the more money will go toward reducing your principal balance and building your equity.

Be aware, though, that some loans don’t operate this way. If you take out an interest-only or other non-amortizing mortgage, you won’t reduce your principal balance or build equity. Instead, your payments will only go toward paying your interest, property taxes and insurance. Eventually, you’ll need to pay a lump sum to pay off your principal balance.

Pay More than the Minimum

If you want to build equity quicker, you can always pay more than your required payment each month. Even paying an extra $100 a month can help you chip away at your principal balance at a faster rate. You might also choose to make an extra payment each year, another way to cut down your loan’s principal balance and build equity faster.

Stay in Your Home 5 Years or More

You’ll build equity if your home increases in value. Of course, no home is guaranteed to see its value jump, but you will increase your odds if you stay in your residence for a greater number of years. Plan on staying in your home for 5 years or more if you want to see its value jump enough to give you an equity boost.

Renovate and Add Curb Appeal

You can help boost your home’s value by adding an extra bedroom, renovating that old kitchen or adding a master bathroom. Investing in landscaping and giving your home curb appeal can help, too.

How to Use Your Equity

Equity is an important financial tool, and one of the greatest financial benefits of owning a home. You can tap into this equity when you sell your current home and move up to a larger, more expensive one. You can also use that equity to pay for major home improvements or to help consolidate other debts. You can even use it to help plan for your retirement.

Not all homeowners have equity in their homes. Fortunately, though, most do. And some owners are equity rich. This means they have at least 50% equity in their homes. ATTOM Data Solutions, a property data provider based in Irvine, California, reports that more than 14 million homes in the United States were equity rich as of the end of the first quarter of this year. That’s 25.1% of all the homes in the country.

Using Equity to Help Buy a New Home

Maybe you’ve lived in your home for 7, 8 or 9 years. Maybe your family continues to grow. Or maybe your job is taking you to a new city. Whatever the reason, you’re ready to sell your home and find a new place to live.

Equity can be your friend as you make this move.

Maybe the home you are selling is worth $220,000, and maybe you’ve built $70,000 worth of equity in it. If you sell your home for what it’s worth, you’ll leave the closing table with a profit. You probably won’t get the entire $70,000 in equity you’ve built. You’ll need to pay for such fees as your real estate agent’s commission and some mortgage closing costs. But you will end up with a solid profit that you can then use for a large down payment on your next home.

With this big down payment, you can get into a larger, more expensive home because your mortgage will be lower. And with a smaller mortgage, your monthly mortgage payment will be lower, also. If your down payment is big enough, your monthly mortgage payment might be smaller than it was with the residence you sold, even if that home was smaller and less expensive.

Borrowing Against Equity

There are three main ways you can borrow against your home equity, a home equity loan, home equity line of credit or cash-out refinance. Using equity is a smart way to borrow money because home equity money comes with lower interest rates. If you instead turned to personal loans or credit cards, the interest you’d pay on the money you borrow would be far higher.

There is a potential danger to home equity lending, though. If you fail to make your payments on time, your lender could take your home through the foreclosure process. That can’t happen when you take out a personal loan or when you charge purchases with your credit cards.

Home Equity Loans

A home equity loan works like a second mortgage. Say you have $50,000 in equity. You might qualify for a home equity loan of $40,000. Once the loan closes, your lender will provide you this $40,000 in a single payment. You can then use this money however you want. You pay this loan back in monthly installments, with interest, just as you pay back your primary mortgage loan.

Home Equity Line of Credit

Better known as a HELOC, a home equity line of credit is more like a credit card, only the credit limit is tied to the equity in your home. If you have $40,000 of equity, you might qualify for a HELOC with a maximum spending limit of $30,000. This means you can borrow up to $30,000, but no more. As with a credit card, you only pay back what you borrow. So if you only borrow $20,000 on a kitchen renovation, that’s all you have to pay back, not the full $30,000.

Cash-Out Refinance

In a cash-out refinance, you refinance for more than what you owe on your mortgage. You again receive this extra money in cash that you can use however you want. Say you owe $180,000 on your mortgage. You can refinance for $220,000 and then take the extra $40,000 in cash. You will repay the $220,000 total in monthly payments, with interest. How much extra you can include in your cash-out refinance depends on the equity in your home.

Before deciding on any of these home equity choices, be sure to speak with a mortgage professional who can help you understand the pros and cons of each.

Using Equity for Your Retirement

If you’re older than 62 and considering retirement, you might explore a reverse mortgage. With a reverse mortgage, you’ll stop making your monthly mortgage payments and will instead receive a check each month from your lender.

How much you can borrow depends on your age and how much equity you have in your home. Maybe you have $200,000 of equity in your home. You might then be able to qualify for a reverse mortgage of $130,000.  You can elect to receive this money in one lump sum or in regular monthly payments.

You don’t pay back your loan unless you sell your home. You would then use the profits from your home sale to pay back the loan. If you die before this, your lender will sell your home and pay back the reverse mortgage from the profits.

The negative, then, with a reverse mortgage is that you won’t be able to leave your home to any heirs. The positive? You can use the payments from a reverse mortgage to help fund your retirement years.

 

 

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This Post Has 20 Comments

  1. I currently own my home free and clear. I’m looking to pull some equity out for home improvements. Not interested in a Heloc. Any suggestions?

    1. Hi Terri:

      We can help you look into options for a cash-out refi where you would have a single mortgage payment and be paid in a lump sum rather than using a HELOC. If you would like, you can either go through your options online with Rocket Mortgage® or give one of our Home Loan Experts a ring at (888) 980-6716. Have a wonderful day!

  2. Hi, I was talking to a friend that was saying they were told Quicken offers up to 85% cash out refinancing on a conventional loan. Is this true? I didn’t see it on the website.

    1. Hi James:

      Your friend is correct. Not every loan option we offer is prominently featured on the website because frankly, there are a lot of them and also a lot of individual financial profiles to try to find a fit for. If you would like to go over your options, I highly recommend speaking with one of our Home Loan Experts at (888) 980-6716. Have a great day!

  3. We have a mortgage with Wells Fargo which orig. in 2009, and our current balance is $349,964.36. We began a Refi process with them last summer 2017, and the appraisal came in at $230,000. So, it didn’t go through. Is this considered really really “negative equity”, and like the “end of the world”? Is there any way out of this?

    1. Hi Dan:

      That would be negative equity. It’s not the end of the world. Depending on when in 2009 was originated, you may be eligible for HARP if it was before May 31, 2009. If that’s the case, you could try to refinance through that as long as your loan is owned by Fannie Mae or Freddie Mac and you qualify. We can help you look into your options at (888) 980-6716. You could also enjoy talk to Wells Fargo about a modification.

  4. My soon to be ex- husband of 40 years wants a divorce. I don’t have the cash to pay him out the $150,000 to keep the house. Would I be eligible for a cash out loan and make monthly mortgage payments? Would I be given a 1099 to write off the mortgage interest?

    1. I’m sorry to hear about your situation. You may be able to keep the house just by negotiating with him and giving up other things. Absent that, you could try to take cash out to pay him for equity stake. You might have to negotiate with him to give you time to get approved. You can talk to one of our experts at (888) 980-6716. You would get a statement to write off the mortgage interest. It’s a 1098. Hope this helps!

      Kevin

  5. We are looking a vacation home. We own our main home and have no mortgage. What is the best way to pull money out to purchase the vacation home and pay off some outstanding debt.

  6. Hi. My wife and I are looking to buy our first home. I read that it is important when making offers to ask the seller how much equity they have in the home. Why would this matter from a buyers perspective? Thanks

    1. Hi Andrew:

      The only time I can think that that would come up is if the appraisal came in lower than they were expecting and they had to pay off the loan still. They would have to make enough off the sale to pay off the loan. The only other time it would matter is that they were gifting you equity, but only family can do that.

      Kevin

  7. We are looking to get a home equity loan. Cant find an application on your site. Could you please assist?

    1. Hi Renee:

      Unfortunately, we don’t do home equity loans. You may be able to accomplish the same goals with a better rate by doing a cash-out refinance on your primary mortgage. You’ll get a better rate because it’s on your primary mortgage as opposed to a second mortgage which carries more risk for the lender and investor. You can take a look at the kind of loan options you would have through our Rocket Mortgage. You’d be able to take a look at how much equity you could take out and at what rate, getting an approval right online.

    1. Good morning, Chelsea. The best way is to have your house appraised. An appraiser will come out and decide how much the house is actually worth. There is also a “zestimate” that Zillow offers, which is an estimate of the house’s worth. Fair warning – this is not always accurate, but it’s a good place to start if you want a ballpark answer. All that being said, if you truly want to know, you will need to have the house appraised.

  8. I was just wondering why you send us a message on the definition of Home Equity, showing a new kitchen, but Quicken Loans doesn’t deal in Equity Loans?

    1. Hey, Tom. Equity goes far beyond equity loans alone. It can be used for purchasing new homes, for your retirement and even for cash-out refinancing. While Quicken Loans doesn’t deal in equity loans, you can still pull out cash with a cash-out refinance. This money is yours to use, so you can apply it any sort of project you want, such as a new kitchen. Take a look at this article about cash-out refinances, which fully details the difference between a cash-out refinance and equity loans.

      Let me know if you have any more questions, Tom. I’ll be sure to point you in the right direction. Have a nice Thursday!

  9. “One confusing part of home equity is that it’s always changing. While you may currently have 5% equity on a $200,000 house, this could easily change with the ebbs and flows of the housing market. If the housing market slips (think 2008), it could mean that your $200,000 house is only worth $185,000. Suddenly, your 5% equity only amounts to $9,250. On the flip side, consider what would happen if your house’s value shot up to $230,000. Then 5% equity would look like $11,500.”

    That’s not how equity works though. You don’t own a percentage. The equity you have is the difference between what your house’s market value is and what the value of the liens against your house are. In the above scenario, the $200,000 house starts with $10,000 equity, but the value dropping to $185,000 results in being underwater with a -$5,000 equity, not a positive $9,250 like the article says. On the flip side, the increase in value to $230,000 results in an equity of $40,000, not $11,500.

    1. Thank you for the second set of eyes, Bob! We realized shortly after publishing this that it needed to be corrected, so we updated it, but the change didn’t reflect on the live site for 24 hours. Thanks again!

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