What Is Equity in a Home and Why It’s Important
Homeownership is a fascinating situation, one that includes many profound and vital financial concepts. However, we've worked with many homeowners who seem confused about home equity. What does this term mean? How does it affect your home value if it does? And how can it alter your financial future? Understanding these topics should help to make your financial future easier to plan.
What Is Equity In a Home? A Deeper Look
Home equity is one of those financial terms that may feel complex to some homeowners. Yet, in many ways, it is surprisingly simple. However, home equity's implications go far beyond its initial concept and range. The following information will help give you the complex understanding you need. It will also help sort through any confusion you might feel surrounding this topic.
A Simple Definition Of Home Equity
Home equity is defined as the difference between your home's value on the market and your mortgage balance.
It gives you an idea of how much money you can draw on your house's value in a loan. We'll talk more about home equity loans later. For now, let's take a deeper dive into the complex meaning of this concept. It can impact your financial health in so many ways if you aren't careful.
We'll take a look at how equity is calculated to give you an idea of how to handle this process. Then, we'll go over other home equity factors to ensure you fully grasp this idea. You can use these ideas in many financial situations to guide your future. Just as importantly, you can avoid confusion or complications with your credit line. So please read on to learn more about this topic.
How to Figure Out Home Equity
Talk to a home equity professional to quickly and easily calculate your equity. They'll take multiple steps to figure out this value for you. However, you can also calculate your equity using a few simple processes. This guideline gives you the basic knowledge you need to estimate your equity. You may be slightly off using this process, but you should have a good idea of what to expect:
Start here by using an online tool that gauges the value of your property quickly and easily. You can also check by finding other similar properties near you. Their value should give you a pretty good idea of your home's value at the moment.
Next, find your last mortgage statement (the one just after you last paid) and find the principal. This number will be listed towards the bottom of your account. Identify your principal and write it down to make sure you remember it for later.
Take your current market home value and subtract it from your mortgage balance. The resulting number is your home equity amount. You haven't made a mistake if it is negative. Equity can be both positive and negative, with positive being better for you.
What happens if your home value is lower than your mortgage? For example, let's say your house is valued at $78,679, and you owe $95,135. You'd have $16,456 in negative equity. You never want negative equity because it limits your borrowing opportunities. It may also affect your credit score. Before moving on, though, let's learn how to calculate home equity percentage.
Figuring Out Home Equity Percentage
Your home equity percentage indicates the percentage of your home's value that your equity takes up. It often helps lenders decide if they want to work with you or not. And it also gives you a feel for your potential borrowing power. The steps required for calculating this percentage include:
Calculating your home equity using the steps outlined in the last section
Dividing your equity by your home's current market value
Multiplying the result by 100
Why Home Equity Matters So Much
Now that we've answered the question “what is equity in a home?” it is crucial to understand why it matters so much. In essence, equity provides a valuable borrowing resource. You can borrow against it, letting you use the money however you want. Many people focus on improving their homes, as doing so can improve equity. We'll discuss how later. For now, let's take a look at a few ways you can use equity.
Create a HELOC
Use your equity to create a home equity line of credit (HELOC). This credit works similarly to a credit card in some ways. You can draw up to 80-85% of your home's value. Then, you draw money from this credit line and pay it back with interest. Understand that interest rates may be variable with this account option. As a result, you may end up paying more money than you'd like to otherwise.
Take Out a Home Equity Loan
Home equity loans let you take out a lump sum of cash based on your home value. Typically, you can get up to 85% of your home's value with a loan. Repayment periods range between 5-30- years and feature fixed interest rates. For many, this option represents a safer alternative to a HELOC. However, your payment amount will vary based on your equity and other factors.
Consider a Cash-Out Refinance
Use your home equity to cash out and refinance your current mortgage. You can borrow up to 80% of your home's value and replace the old mortgage with a new one. The new mortgage is larger than the old. The difference between the two goes directly to you. As a result, you can use it any way you want. For example, you can fix up your home, go on vacation, buy a car, etc.
Debate a Reverse Mortgage
Consider this option if you're 62 years or older with low or no mortgage balance. It lets you borrow against your equity to get a loan. This repayment cycle varies and may even pass to your children or others when you pass away or move out. At this point, they can sell the property to pay off the loan. We strongly suggest only getting a reverse mortgage if you're in dire need of money.
Finance a New Home or Move to Rental Property
Borrow against your equity to produce the downpayment for your new home. This option works well for those who've upgraded their house and accumulated a lot of equity over the years. However, some also sell their home to cash out their equity and move back to renting. This option works for those who can't handle the burden of owning and maintaining their home or property.
Advantages And Disadvantages Of Borrowing With Home Equity
Not everyone will borrow using against their home equity. Some may find it doesn't work for them and use alternative methods.
However, equity primarily provides many benefits for the right borrower. Just a few ways that it helps include how it helps when:
These benefits make borrowing against your equity a wise choice. That said, this step might not be suitable for everyone. Many situations exist in which borrowing against your equity is a poor decision. Let's take a look at a few of these drawbacks to make your situation smoother and easier to understand:
Producing a Much Lower Interest Rate
Lenders love when borrowers use equity because it works as a little more collateral. As a result, they typically adjust your interest rate accordingly. Even if you have poor credit, your equity may help to offset this issue and give you better rates than you'd get otherwise
Letting You Use the Money However You Want
Many types of borrowing situations restrict how you use your cash. For example, mortgages may only be used for homes. However, borrowing with home equity using the methods above lets you use the money however you want, in most cases
Creating Tax-Deductible Interest and Payments
If you're willing to go through your taxes and itemize each deductible, you may deduct home equity interest rates and payments. Talk to your tax professionals about this situation to see if you qualify or not.
Providing a Surprising Amount of Money
Home equity lets you take up to 85% of your home's value, though the amount you get will vary. This high borrowing level is rare in the financial world. Combined with fair interest rates, and you might pay back your loan reasonably quickly if you're wise.
Potentially Allowing for a Stable Financial Amount
If your home's value is stable, equity works well. Unlike other types of options, this more durable design may minimize financial loss. However, this benefit does vary on the market and changes that may be out of your control.
Default Is Very Strict
When you default on a home equity loan or HELOC, you might end up losing your home. Talk to your lender to see what kind of late payment penalties they levy. Default typically doesn't occur after one missed payment but may quickly spiral out of control if you're not careful.
Your Debt Goes Up
Trying to live a debt-free life? Don't use home equity when borrowing money. Doing so adds more debt to your home and makes a balanced financial lifestyle more difficult. Instead, carefully consider this option to ensure that you don't suffer any financial setbacks.
Potentially Limited Credit Use
When opening a HELOC, you typically draw on your credit when you want. However, market conditions could limit your ability. Even worse, if your income drops or your credit worsens, your equity may be limited. Keep these factors in mind before opening any equity credit.
Home Values Could Affect Equity
What happens when your home value dips due to market conditions? Your equity decreases as well. This potential issue may make equity more volatile than some options. Thankfully, home improvements may also help minimize this risk.
Take these negatives into account before considering equity for borrowing. Understand, too, that you can increase your equity in many ways. Knowing how can ensure that you get great results for your needs. The following steps will guide you through this process and satisfy your needs.
Ways To Build Your Home Equity
Building home equity centers decreasing how much mortgage you owe or improving home value. The first option may require working with your lender or taking other steps to boost mortgage payments. The other option often centers around renovations and other measures that make your house more attractive.
Thankfully, most homeowners can try a handful of options to get great results. The more you increase your equity, the more borrowing power you possess. Think of it this way: if you owe no money on the house, your equity is the current market value of your home. So, try these steps to get started:
Improve Your Home
If you can improve the value of your home, you can increase your equity more than you might think. After all, your mortgage value will continue to decrease as your home increases in cost. Simple maintenance steps may help here, as do extensive renovation projects. Find things with a high return on value (ROI) to get great results. Garage improvements often work well for this step.
Make All Monthly Payments
Make all of your monthly mortgage payments on time to ensure that your equity continues to increase. While it's true that your equity will only increase this way slowly, it's better than no improvement at all. Consider a lump sum payment (if you can afford it) to your mortgage to boost your home equity and improve your borrowing capabilities immediately.
Increase Monthly Mortgage Payments
Most people pay the minimum allowed cost for their mortgage payments, extending their repayment cycle as long as possible. However, if you add even a couple extra hundreds of dollars to your monthly payments, you cut back more on the principal. Also, remember that much of your mortgage payments go towards interest at the minimum level of repayment.
Refinance For a Lower Cost
Talk to your lender about potential finance options for your home. If you can finance for a lower price, you may increase your equity. Typically, this process requires a large downpayment before they'll agree. In addition, this option is not available from all lenders. So, make sure you do your research to determine if you can even consider this option for your financial needs.
Is it a good idea to work with another lender to pay off your mortgage? That depends on a few factors. First, the new loan must have better interest rates than the last. If not, you'll end up paying more than you would have with the original mortgage. Try for a fixed-rate option whenever possible when rates are low.
Second, the new loan must have reasonable payment cycles that make sense for you. Most home mortgages last at least 30 years or so. By contrast, many personal loans possess much shorter payment cycles. Don't get caught in a debt trap here. Pay attention to these factors and find a lender who you can trust to handle this process for you.
Getting Help With Us
Are you still confused about home equity or any other topic covered here? Then, you should download our free application today. It lets you search for various lenders based on your financial needs. Do you need someone who will work with a poor line of home equity? Change your search parameters to find someone you can trust. Do you have a bad credit score and need a loan? Our app will help you there.
Set up the parameters that make sense for you and click search to start looking for lenders right away. You can then use the contact information available on each listing to learn more. With our help, you can sort through confusing lists of potential lenders. Make sure to set up your profile when you begin, which will let you save your searches and come back to them later if you need.
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Don't Neglect Your Home Equity Situation
By now, you should feel comfortable about your home equity. You likely understand what this term means, how it impacts your financial situation, and what you can do to change it. Just as importantly, you know how to find a lender willing to work with you. Now, use this information to get fantastic results! Finally, don't forget to share this post with anyone else that you think might need this kind of home equity help.