Home equity in real estate can be termed as ownership value built into a home which is a representation of the home’s market value minus pending mortgage payments. This value grows as time goes by as the owner of the property makes mortgage payment thereby increasing the home’s market value.
Equity can be determined by taking the home’s market value and subtracting from it any pending loan balances.
Home equity can be viewed as the share of the home that you actually own. While you are considered the overall owner of the home, the fact that you purchased the home using borrowed money which is yet to be paid off means that the lender partially owns the home until the loan is completely paid off in full.
The asset with the highest value to a homeowner is home equity. The homeowner can use it to his/her advantage in the future. It is therefore vital for him/her to have a perfect understanding of how it works and use it wisely.
Let’s review an example of home equity: Assuming you bought a home for $500,000 and placed a 20% down payment for it which amounts to $100,000, which you took from your own savings. You then acquired a loan to cater for the pending $400,000. The home equity interest that is due to you is 20% of the value of the home.
The total value of the home is $500,000. You paid $100,000 with your own money, amounting to 20% of the overall price which is $500,000. This means that you have ownership of the home, but in essence, your value of ownership for it is $100,000, or 20% equity stake.
The loan lender technically owns no part of the home since the officially recognized homeowner is you. The home, however, acts as a collateral or security for the loan you took to pay for it. The lender’s interest is secured by having a lien on the house.
In the event that the value of your home doubles and becomes $1,000,000, the amount that you owe the lender still stands at $400,000, but your equity stake increases to 60%. The way to determine this is by taking the loan balance, which in our case is $400,000 and dividing it by the new market value which is $1,000,000 and then subtracting the acquired result from one. The answer in decimal form is then converted to a percentage by multiplying it with 100.
It is important to note that the loan balance that you’re due to pay still remains the same but there is a substantial increase in your home equity which is a plus for you.
So how can you grow your home equity? Below are a few ways that you can do it:
- Repaying Your Loan
As you continue paying off your pending loan balance, you increase your home equity. A large number of home loans are Standard Amortizing Loans where monthly payments are projected towards your principal and interest. With the passing of time, the amount incurred for the repayment of the principal increases, thereby building your equity at an additional rate each year.
If you’re operating with an Interest-Only Loan or any other form of a non-amortizing loan, equity cannot be built up in a similar manner. You may be required to have additional payments to minimize the pending debt and grow your equity.
- Increasing Price
Another way to build equity is when your home increases its value, this being independent of your actions or influence. It can be sponsored by a vibrant real estate market or the rise of better projects.
So how can you make use of home equity is a question you may be asking. Equity being an asset forms a section of your overall net worth. You may decide to one day make a single withdrawal from your equity or retain it and pass it down to your successors.
Below are some of the different ways you can use your home equity:
- Use It To Purchase Your Next Home
You may not live in the same home forever. If you plan to shift to a different home, you can opt to sell your current house and invest that money towards purchasing another one. If there are pending mortgages, you can’t use all the money you get from the sale, but you can use the equity.
- Take Up A Home Equity Loan
You can take up a Home Equity Loan and get money to spend on any need or activity you may have at hand be it paying for school fees, home improvement, purchasing a car, whatever need that the money can meet.
- Finance Your Retirement
You can spend your equity in the years after taking up retirement through a Reverse Mortgage. Such a loan becomes a source of income to you when you retire and need no monthly payments. Their full repayment happens when you vacate from the home.
It’s important to note, however, that these loans are complicated and may pose potential problems to you as a homeowner in the future.
One other important aspect to consider concerning home equity is home equity loans. They allow you access to huge sums of money at low-interest rates. They are backed up by real estate making them easy to qualify for.
You can access a home equity loan by applying with lenders who evaluate the house’s market value and determine the amount that you can borrow. You can get a Home Equity Loan where you receive a lump-sum of money and repay it at a fixed rate with flat monthly repayments over the years.
A HELOC (Home Equity Line Of Credit) makes the provision for you to draw funds as per your need. You have the provision to borrow the specific amount that you need within the draw period so long as you maintain an open line of credit. Minimal payments can be made on the debt.
Once your draw period ends, you’re expected to repay all your debt aggressively with no delays and clear it off fast. Applicable interest rates are variable.
They, however, have risks attached to them, one of them being that your house acts as the loan’s collateral. In the event that you fail to repay the loan, the lender has the authority to take over the home in a foreclosure and sell it to recover their money. This will most likely send you back to renting.
Home equity can work well for you as a homeowner if you have a proper understanding of it. With this insight at hand, you can use the home equity available to you in your favor and accomplish more with it. Make the best of this great asset.