Understanding Home Equity: What are the Benefits
There’s a lot of talk around home equity and growing home values. But what does it all mean? How can you truly benefit from it?
What is equity?
Your home equity is your home’s worth when not considering any debts against it. It is essentially the portion of your property that you truly “own.” To calculate it, take the difference between the appraised value of your home and your current mortgage balance.
Let’s consider an example:
If your home appraises for $400,000 — yet your balance is $285,000 — you have $115,000 in earned equity. So, you own about 30% of your house while the rest remains held by the bank. Still that $115,000 is yours and a percentage of it may be available to you in the event you want to refinance and cash out.
How does home equity grow?
Equity can increase over time as your home value increases. The increase may come from a home remodel or merely owning a home in an appreciating real estate market. For example, if you borrow $50,000 from your home equity to cover the cost of home improvement and you’re able to increase the property value by $75,000 — you’ve just increased your investment by $25,000. Similarly, if your neighborhood and local economy see improvements, your property can benefit just by being a part of that appreciation. If you’re buying in Denver, Portland, or Seattle, chances are pretty high you’ll see a lot of equity growth just because of the local economy and real estate market.
Equity can also grow as you pay down the principal of your loan balance, as opposed to paying toward interest.
Our extra mortgage payment calculator can show you how you can build your equity faster and save and interest over the life of your loan.
How to calculate your home equity
Outside of following the formula at the beginning of this article, you can also calculate your home equity by requesting a comparative market analysis (CMA) from your realtor, or through hiring an appraiser to conduct an appraisal.
A comparative market analysis is an examination of the prices at which similar properties in the same area recently sold. Similarly, an appraisal is an estimated value of the property, that an appraiser determines. It's specific to the home, not the neighborhood. Such actions are often (only) taken once you are looking to list your home and move on to something new.
How can you use equity?
Home equity is very beneficial when you're in need of a large sum of money. You can access your home equity via a home loan refinance or a home equity loan (or HELOC). The money received from your mortgage refinance or home equity loan can be used to:
Pay off high-interest debt
If you have confidence in your ability to not rack up debt once it’s paid off, consider a cash-out refinance or a refinance that consolidates your debt. Student loans and credit cards carry some of the highest interest rates around. By rolling those debts into your mortgage payment, or even paying them off altogether, you can be saving hundreds of dollars each month.
Make a down payment on a new home
Since many homeowners move at some point in their life, it’s common to use proceeds from your home sale to cover the cost of a new home down payment. Some of the money from the sale will, of course, pay off your existing mortgage, but the rest is likely a result of your equity growth and can be used however you’d like.
Cover the costs of home renovations
It’s very common for homeowners to use their home equity to invest in their home. By taking funds out to complete significant repairs, you can further increase your home value. Consider finishing your basement or making kitchen or bathroom updates.
Check out our top improvement projects article that discusses which projects provide the best return on investment.
Fund major life expenses
Equity can also be used to pay for a considerable cost like college tuition or a wedding. Again, it’s your money, so it’s your choice on how to spend it. If you’re interested in taking advantage of the equity in your home but are unsure how to get started, we recommend reading our article on home equity loans.
Supplement your retirement income
Finally, if you’re 62 years of age or older, you can take advantage of your home equity through a reverse mortgage. As a borrower, you are required to continue paying for homeowners insurance, property taxes, and basic home maintenance. Should you be able to maintain the property and keep up with such payments, you may be able to take out funds from your home without giving up ownership. This results in you being able to use the equity to pay off an existing mortgage or to preserve your retirement savings, as a reverse mortgage can provide you access to tax-free cash.
Is it possible to have negative equity?
Yes. If your mortgage balance is higher than your home’s current value, you could find yourself with negative equity. This usually aligns with a slowing of the economy that results in home prices dropping. Another common industry term is “underwater.” In the event your home is underwater, some options may help you recover. For example, the Home Affordable Refinance Program (HARP) was designed specifically for people whose equity was negatively impacted as a result of the 2008 market crash. Thanks to HARP, homeowners could (and still can until December 31, 2018) refinance their loans to better terms.
To learn more, give one of our salary-based mortgage consultants a call. We can help you better understand equity, as well as the personal benefits it can offer to better your financial situation.