What Is Home Equity and Why Does It Matter
Many first-time homebuyers may not realize exactly what home equity entails. Essentially, it is the portion of the home that you actually own. With a mortgage on the house, you don’t own it yet in full—at least, not until you pay said mortgage off. Before buying, understanding home equity and why it matters to your situation is important.
Understanding Home Equity
When you take out a mortgage to get a loan for your home purchase, you don’t truly own your house. Despite your name being on the title, you also have a lien holder in place. Should you stop paying your mortgage, the home goes to the lender who helped you get it. Determining your home equity requires subtracting the mortgage amount from the actual home value.
If you sell your property before the mortgage is up, the equity is the portion that would be your proceeds. Everything else would need to go back to the lender to pay what you still owe. As you make your monthly payments, your equity increases little by little.
The Importance of Equity for Homeowners
Home equity is important because it protects you to some extent. If you were to owe more on your mortgage than what the home is even worth, it wouldn’t be a worthwhile investment. You need to build strong home equity to actually make something back should you sell. You can also use your equity to take out a loan or refinance your mortgage.
Most lenders will not allow you to borrow against your equity until you have at least 20 percent. If they allow you to borrow with a smaller amount of equity, there is no doubt that you’ll be paying much higher interest rates. Gaining equity gives you more power.
Why Equity Takes Time to Build
Equity takes time to build because the loan is so high. If you still need to pay $200,000 on a $300,000 loan, for example, you have a lot of payments to make before you gain your equity—and more power because of it. The longer you stay in your home and continue to make on-time payments, the more equity you can build and utilize down the line. Paying off just one extra mortgage payment per year can be a huge help toward gaining your equity more quickly.
Someone with a shorter loan term also builds equity more quickly. If you’re expected to make a larger payment each month, you have a more significant amount added to your equity. You will also have the mortgage paid off more quickly and can therefore use your full equity sooner than you would with a long-term mortgage plan. This means taking a 15-year loan rather than a 30-year one and paying double the monthly amount. However, it’s worth it if you need the equity sooner, such as when you know you’ll want to sell and buy a new home in a few years rather than staying in the home forever.
Ways to Utilize Home Equity
Once you know the answer to “what is home equity,” you can determine ways to utilize it. Many use their equity as a larger down payment toward their next home. Once you pay off your mortgage, you can take what’s left and use all or most of it toward a much larger down payment than you might otherwise be able to provide. This means a lower monthly mortgage payment for this second (or third, fourth, and so on) home than you would have previously been able to offer.
Another great way to use your equity to your advantage is to utilize it for home improvements. Updating your home can increase its value. Since equity is market value minus mortgage, increasing the value of your house can drastically improve your equity on the spot. Take out a loan against your equity and use it to pay for a new pool, solar panels, appliance updates, and more to enhance the look and appeal of the space. Even minor projects like painting and deep cleaning can add to the attractiveness of the home and entice a new buyer.
Some people even use their equity as a supplement for retirement income. Whether needed for necessary home improvements or needed to have the money to pay for medical expenses, it’s something you can use to help your situation.
You may even take out a home equity line of credit just for the lower interest rate. You can use it to pay off other debts you owe at a lower rate than what those original debtors were charging. It helps save you a bit of money in the long run. You can also save by shopping around and finding a company with better rates. Just be aware that borrowing against your equity could leave you without any if you find yourself unable to pay it back. You are also using your home as collateral. Just as if you didn’t pay your mortgage and lost your house, you could lose it for taking out this line of credit and not paying it.
Once you understand the question, “what is home equity,” you are better prepared for the buying and selling process. Contact us at Offercity with any additional questions that you may have so that you can feel confident about selling your home or a future purchase.