If you bought your home before you ever heard of COVID-19, you probably have an asset that’s worth substantially more than you paid for it. With the high demand for housing and the historically low inventory, home prices have soared in the past few years. That means that homeowners are sitting on a lot more equity than they might realize.
What is Home Equity?
Equity is the difference between what your home is currently worth and what you owe on your mortgage.
Example:
You purchased a home at market value for $300,000, put $30,000 down & financed $270,000. At that point you have $30,000 equity in the home ($300,000 minus $270,000 = $30,000 in equity).
Several years later, you’ve been making your mortgage payments and you now owe $260,000 on your mortgage. At the same time, your home’s value has increased to $350,000. Your equity is now $90,000 ($350,000 minus $260,000 = $90,000 in equity).
How To Build Home Equity
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 larger down payment. This may not be a viable option for some homebuyers, but it is a great way to get immediate equity.
Pay More Than the Minimum. If you want to build equity more quickly, you can always pay more than the required payment each month or make an extra payment each year. This also helps you chip away at the loan’s principle balance.
Stay in Your Home Five or More Years. The longer you stay in your home, the more equity you’ll have as the home increases in value. Of course, there’s no guarantee how much your home will increase in value but your odds are better, the longer you stay in your home.
Renovate and Keep Up With Maintenance. It’s vitally important to stay ahead of home maintenance. Deferred maintenance can count against you especially when it comes to maintaining such things as heating & cooling systems, electrical issues, and appliances. You can also add to your home’s value by renovating and updating. Updating kitchens and baths can substantially increase the value of your home as well as updating flooring, lighting, landscaping, etc.
How To Use Your Home’s Equity
Use Your Equity To Buy a New Home. You can tap into your equity when you sell your current home and move up to a larger, more expensive one. Using your equity can make it possible for you to make a large down payment on the new one, which will help make your mortgage payment smaller.
Get a HELOC, or Home Equity Loan. If you’re not going to sell your home and use your equity for your new one, then you can access your equity through one of these options. Both of these are classified as a second mortgage. To obtain one of these loans, you’ll need to go through a similar process to obtaining a mortgage. You can apply through a bank, credit union, online lender or any other financial institution. Your lender will take into account your debt-to-income ratio, loan-to value ratio, credit score, annual income, etc. They will also hire an appraiser to determine the current market value of your home.
The type of loan depends your needs and what you plan to use the money for. If you’re looking to spend as you go and only pay for what you borrow, a HELOC (Home Equity Line of Credit) is probably a better option. Think of it as something similar to a credit card. When you need it you can access the funds.
However, if you’re looking for a fixed monthly payment and a large sum of money up front, a home equity loan or HELOAN is probably the better option. You’ll receive a lump sum of money that you can use to take care of the expenses or projects you have in mind.
Some of the things you can use a HELOAN for include:
- Home improvements and upgrades that can add to the value of your home
- College costs to fund a child’s education
- Debt consolidation to consolidate high-interest debt at a lower interest rate, such as car loans or credit cards, etc.
A Word of Caution
HELOANs and HELOCs have advantages over other types of debt, such as personal loans or credit cards, because they have lower interest rates and usually have more favorable terms. But those benefits are there because if you don’t pay, the bank can take your house.
Just like any other loan, there are risks that you should consider. The value of your home can decline. In today’s market that doesn’t seem likely, but there’s no guarantee that, over time, your home will appreciate substantially. Your home could also lose value due to damage caused by fire or weather. If the value of your home declines, you could end up owing more between the loan and your mortgage than the home is worth. This is known as being “under water.”
There’s a limit to what you can borrow. Even if you have a substantial amount of equity in your home, most lenders won’t let you borrow the full amount.
The Bottom Line
Equity is an important financial tool and one of the greatest financial benefits of owning a home. However, if you decide to use your equity, educate yourself on the types of loans available, their cost and risks, and avoid using the money for extravagant purchases or non-essentials.
Contact the Donnelly Group
If you have questions about home equity and how best to access it, the team at the Donnelly Group have the expertise and the contacts to help you make the right choice. Please don’t hesitate to contact our team at 480-792-9700 or by email.
