The difference between the amount of mortgage loan owed and the value of your home is the equity in a house. For example, if the amount of outstanding balance you owe on your mortgage loan is $130,000 and the value of your house is $180,000, the equity is $50,000. With this equity, you can take out different types of loans such as equity loans, lines of credit, a reverse mortgage, cash-out refinance loans or take an additional mortgage. These loans allow you to turn your equity into cash.
How Does Home Equity Work?
Your home equity works in two ways. Your equity can increase when the value of your home increases but the equity can also decrease when home prices decline. The second way your equity can increase is by reducing your mortgage balance over time with regular payments or making extra payments to expedite the mortgage reduction. As your equity increases over time, there are more options to withdraw your equity through loans. These loans are at significantly lower rates than personal loans or finance company loans.
How To Build Home Equity
Building equity is easier than you think. Here are a couple of things you can do:
1. Pay a larger down payment
Paying a larger down payment means that the amount of the mortgage loan will be lower and accordingly, the difference between the value of your home and the money you owe, that is your equity, will be higher. If this is not an option, the equity growth will be more dependent on home prices increasing.
2. Make additional payments
A second way to build equity is by making additional payments. This means paying more than the minimum required payment. When making additional payments, this will decrease the loan balance quicker which creates more equity. However, if extra payments are made, it is imperative to identify the additional payments as “additional payment towards principal” so that the lender doesn’t apply the additional payments towards your interest. Many lenders will do this and it is a huge disservice to the borrower.
3. Reside in the house for at least 5 years
While it is not certain that housing prices will increase over time, the chances are still high, which is why you should reside at the house for a certain amount of time to take advantage of the equity. The longer you stay, the greater the reduction to the mortgage balance and the higher the value of your house.
How to Calculate Your Home Equity
To calculate your home equity, you need to know the value of your home and the current mortgage balance, which is written on the monthly statement. Then, you need to subtract the current mortgage balance you owe from your home’s market value. For example, if the amount you owe on your mortgage loan is $130,000 and the value of your house is $180,000 (not counting closing costs), the equity is $50,000.
To get the correct value of your home, you need to contact a real estate appraiser who can give the accurate current market value of your home. Another option is to look at online sites and use their evaluation. But, remember that these estimates are not always accurate and a real estate appraiser can provide you with a better evaluation.
Example of Home Equity
Let us give an example of home equity that illustrates it more clearly. Let’s assume the purchase price of a house is $200,000. The down payment is 10% or $20,000. The mortgage lender then offers a mortgage loan for the amount of $180,000. Here, the home equity will be $20,000.
After some time has passed, you’re paying the mortgage over time in monthly installments and you owe $170,000. However, the value of your home has jumped to $210,000, which means your equity is now $40,000. Alternatively, if the value of your home drops, let’s say it becomes $195,000 and you owe $170,000 on your mortgage, your equity will be $25,000.
How to Increase Your Home Equity
Here are some of the ways you can increase your home equity:
1. Pay a big down payment
When you put down a larger amount, your mortgage loan will be smaller and your equity—the difference between the value of your home and the amount you owe—will be higher.
2. Increase your home’s value
The higher the value of the property, the higher the equity. You can increase your home’s value by doing renovations and upgrading it. But, keep in mind that not all renovation projects will give you the return you want. Thus, before you invest your money into property improvements and curb appeal, make sure to consult a real estate agent or some other professional, who has an idea about the real estate markets, to discuss renovation projects that will give you high returns on property values.
3. Wait around for your house value to increase
Housing markets are changing all the time and if you stay in your house long enough, you will find the value of your actual property increases with time. Although there is no way to influence such market shifts and real estate market cycles, the values generally increase over time.
4. Go for a short loan term
A shorter mortgage term usually has a lower mortgage interest rate and most importantly, a larger percentage of the mortgage payment will go to your loan balance or mortgage principal every month. This will help you with your equity growth. But, remember that a shorter loan term or draw period means bigger monthly payments and a shorter repayment period. So make sure that you can afford it before you change your original mortgage.
Can The Equity In Your Home Change?
Yes, the equity in your home can change. It depends on the house prices. If the value of your home increases, the equity will increase as well. Alternatively, your equity can decrease if the home values decrease. However, over long periods of time, the equity almost always increases which also increases the homeowners net worth. To speak with a mortgage professional contact the Cain Mortgage Team today.