June 1, 2022
Understanding Home Equity and What You Can Do with It
Have you ever asked yourself, how does home equity work? It’s a confusing topic that isn’t always too clear to understand home equity is the part of your home that you actually own as determined by the market value minus the existing liens on the property, including the home equity line of credit or the mortgage. Tapping into your home equity to finance home improvements or pay off debt is a smart move in certain situations. In today’s blog, we’ll go over what exactly home equity is and what you can do with it.
What is Home Equity?
Home equity is the difference between the value of your house and your current outstanding mortgage debt. At the moment of the purchase, your down payment is your home equity. However, the amount of home equity you have changes over time as you continuously make your mortgage payments and the market value of your home increases or decreases. As you build more home equity with time, you can decide to access it for any purpose. Some examples would include:
- Pay down other types of debt
- Finance home improvements
- College Costs
- Emergency Expenses
- Business Expenses
However, you first need to understand how home equity works and analyze whether it’s the right financial move for you.
Why is Building Home Equity Important?
Building home equity is essential because it can give you financial flexibility and access to your home equity. As a homeowner, you can access the equity you have built in your home by taking out in:
- Cash Out Refinance
- Home equity loans
- Home equity lines of credit (HELOCs)
Both of these debt products give homeowners access to their home equity in exchange for cash—which can be used to pay off consolidated credit card debt, pay college tuition, go on vacation, or renovate your home. Home equity also gives homeowners an extra source of funding and the financial flexibility they need. The amount a homeowner can borrow, however, will depend on the current amount of home equity they have. For the majority of Americans, their home is their largest asset. By building equity in your home, you’re growing the value of your assets and increasing your net worth.
How to Build Home Equity
Building home equity requires time, but is an easy process. Here’s how to do it:
Buy Your Home
To build your home equity, you will have to quit renting and take the big step of buying a home. When you own your home, the changes in real estate will help boost your equity with time. Under ordinary market conditions, home values appreciate every year. As the value of your home goes up, so will your home equity.
Peter owes $200,000 on a home worth $250,000. His home increased in value the next day to $260,000. The value of his home equity increased from $50,000 to $60,000.
Any type of down payment you make when you first purchase your home also gives you equity.
Increase Your Mortgage Payments
Another way to increase your home’s equity is by making payments toward your mortgage. Unless you have an interest-only mortgage, every monthly payment you make gets split between interest and your principal balance. The part that pays down the principal balance will help you build equity by decreasing your debt. Unfortunately, when you first start paying your mortgage loan, only a portion of your payment will go towards the principal since most of the money will be going towards interest. On the bright side, the payment that pays down the principal increments as time goes by.
You can also make additional payments on your home loan to build up your equity more quickly. When you pay more than the monthly minimum, all of the extra money will go directly to your principal balance. When you reduce your mortgage balance more quickly by making the extra payments, the interest used the next month will be less. As a result, the portion of your next payment that goes to your principal will be slightly bigger. Every time you pay a little extra on your mortgage, you will increase the rate in which you build your home’s equity. Before you do this, it’s important to check with your lender to see if there is no penalty for paying off the loan earlier than expected.
The Importance of Yearly Reviews
Existing homeowners have built a lot of equity over the last ten years. Annual financial reviews are important so you can understand your equity and what you can do with it. At Community Mortgage, we provide our clients with yearly reviews that help them understand their current equity position and know what they can do with it. As a homeowner, understanding these concepts is important, especially if you want to build wealth with your home over time. We hope this blog helped you get a good understanding of home equity and what you can do with it. At Community Mortgage, our competent team is more than happy to help you achieve your goals! Give us a call at (619) 692-3630 or click here to schedule a FREE consultation.