What is Home Equity?
Home equity is that portion of the value of your home that is not secured by mortgage liens. In other words, it is the part that you freely and clearly own because it is not owed to any mortgage lender.
For example, if your home is worth $ 250,000 and you owe $ 100,000 on your mortgage, you have $ 150,000 in equity.
Home equity is a valuable commodity in itself. But equity can also be used to grow your wealth if you know how to use it properly. This is how it works.
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How to Calculate Home Equity
There are only two things you need to know in order to calculate your own equity:
Current market value of your home Your total outstanding mortgage balance (primary mortgage plus secondary mortgage, if any)
From here the equation is simple:
Home Value – Total Mortgage Balance = Your Home Equity
Here is a very simple example of calculating home equity in practice:
Home Value: $ 200,000 Mortgage Loan Balance: $ 100,000Home Equity: $ 100,000 ($ 200,000-100,000)
Typically, homeowners build equity in two ways.
First, as you pay off your debt, the mortgage balance goes down a little each month. The lower your mortgage loan amount, the higher your equity.
Second, rising property prices tend to increase the property's market value. As the value of your home increases, your equity automatically increases.
Find your mortgage balance and home value
Finding the outstanding balance on your home loan is easy. You can probably log into your mortgage account for an accurate and up-to-date number. Or you can check your last paper statement.
Determining the current market value of your home can be a little trickier.
In most cases, this is not the same as the purchase price you paid when you bought the home, as real estate tends to increase in value over time.
You can get a rough idea of the current value of your home using online valuation services like Realtor.com, RE / MAX, and Zillow. Or maybe you already know the prices similar homes were sold for in your neighborhood.
You may even be able to seek help from a friendly local real estate agent if you have a friend or acquaintance in the business.
What is the purpose of home equity?
Home equity is a valuable asset and a major benefit of home ownership. This is one of the most important ways individuals and families create wealth and financial security.
Remember that equity is not a liquid wealth. Usually you will need to take out a loan to access it (more details on this below).
However, once you have enough equity, there are a number of ways you can actively use it to your advantage.
Some of the greatest ways homeowners can benefit from their equity are:
The ability to borrow large sums of money from your equity at a very low interest rate, maybe for emergencies or large expenses like home renovationsUse equity as a lever to lower your mortgage costs. Homeowners who build enough equity can get rid of private mortgage insurance (PMI) and sometimes refinance at a lower interest rateIncrease your bottom line when you sell the house. The more equity you have, the more money you will make when you eventually sell. This can be a significant benefit for homeowners moving to a new home or downsizing in retirement
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Borrow large sums of money from your equity
One of the main benefits of building home equity is that you create a pool of assets that you can borrow from.
When you borrow money from your equity, the loan is secured on your home (just like your original mortgage). That means that home buying has far lower interest rates than other sources of money such as credit cards or personal loans.
For homeowners with enough equity, this is often the cheapest way to fund large expenses, such as:
Of course, taking up your own home is not a free ride. You are still borrowing from a mortgage lender even though you feel like you are borrowing from yourself. That means you are paying interest on the loan. And ultimately, you increase your debt and reduce your wealth.
So it is best to only do this when needed. For example, if you have a huge and unexpected medical bill, or are starting a new, surefire business, or have a pile of expensive debts and need to consolidate them.
Incidentally, the federal regulator of the Consumer Financial Protection Bureau warns against "taking out loans from your home as part of an investment strategy".
Cancellation of mortgage insurance
Many homeowners find private mortgage insurance (PMI) a real burden.
If you pay PMI on a conventional loan or Mortgage Insurance Premiums (MIP) on an FHA loan, you can easily add hundreds of dollars to your monthly mortgage payment.
The good news for homeowners with conventional loans is that they can stop paying PMI once their equity reaches 20%. You simply call your mortgage loan service provider and have them removed.
However, this rule does not apply to FHA loans.
What FHA homeowners can do when they have 20% equity is refinance a conventional loan with no PMI.
Your 20% equity counts as a 20% down payment and thus exceeds the threshold at which mortgage insurance is no longer required.
Get a lower mortgage rate when you refinance
When lenders consider a mortgage application, they focus on three main points:
Your creditworthiness your debt-to-income ratio (DTI) your credit-worth ratio (LTV)
Lenders adjust the mortgage rate you specify to take into account how you measure yourself against these criteria.
The more home equity you have when you refinance, the lower your loan-to-value ratio. This is a good thing in the eyes of lenders as it reduces your risk as a borrower and is likely to offer you a lower mortgage rate.
And in the meantime, if you've managed to improve your credit score and pay off some of your debt, that rate could be extremely low.
Increased Profits When You Sell Your Home
Home equity can also serve as a nest egg for your future life and help you save money when you move or retire.
If you sell your home, a portion of the proceeds will be used to pay back your remaining mortgage balance. The less you owe on your mortgage and the more equity you have on the sale, the more money you will get from the sale.
These funds can be used to pay a down payment for your next home or, in some cases, even buy the property directly with cash.
For retirees who are downgrading to a smaller home or community with lower housing costs, paying out home equity when selling can also represent a flat rate for the cost of living.
How do I access my equity?
Home equity is not a liquid asset. Although it is one of your assets, the money is tied up in your home. You cannot "spend" the value of your home per se.
To access your home equity and convert it into cash, you must either sell the home or take out a loan secured by its value.
Of course, you wouldn't be selling your home for access to equity unless you wanted to move anyway. Therefore, most homeowners looking to cash out their home equity while living in the home use one of these three methods:
Disbursement Refinancing – Receive a new mortgage with a larger loan amount to replace your existing mortgage and receive a check for the difference. Typically these have the highest closing costs but the lowest mortgage ratesHome equity loan (HEL) – You borrow a lump sum as a second mortgage. You usually pay it back at a fixed rate over a set period of time. This is a second monthly payment in addition to your primary mortgage paymentsHome Equity Line of Credit (HELOC) – This is a bit like a credit card. You are given a credit limit that you can borrow, repay, and borrow as many times as you want within a specified period of time (the “Draw Period”). HELOCs usually have floating rates that are much, much lower than credit cards. However, these loans are complicated. So make sure you fully understand them before you commit
There are other ways that you can use your equity as well.
For example, you can take out home improvement loans with an FHA 203k purchase loan or a refinance. If you're 62 or older, you can also look into reverse mortgages that provide cash but add interest and loan costs so you don't pay anything until you move or die.
It is important to recognize that all of these loans – including HELs and HELOCs, which are "second mortgages" – are secured loans. They use your house as security. So if you fall too far behind in payments for any of them, you could face foreclosure.
Home Equity Loans, HELOC, or Payout Refinancing: Which Is Right For You?
Choosing between a payout refinance, a home equity loan, or a home equity line of credit is something you want to get right. So read it through carefully. See:
We don't have a place here to tell you everything you need to know. But here are some of the key features of these loans:
Withdrawal refinances tend to have lower interest rates than HELs or HELOCs, but higher acquisition costs. Home equity lines of credit (HELOCs) often have the lowest upfront fees of the three and are the most flexible. But they are also complex and have drawbacks that sometimes lead to careless borrowers. Home equity loans and HELOCs typically have a shorter repayment period than payback refinances, and you have a smaller loan amount, which means you pay less interest, you will likely pay less interest if you use any of these products to borrow a large amount as if you were using a loan that is not backed by your home, such as a home loan. B. a personal loan. But personal loans have lower (or often zero) closing costs. So you might be better off if you want to borrow smaller amounts. You need to shop around to get the best deal on all of these products. Quotes vary widely and you can save thousands by finding the right lender for you. Pay attention to the Annual Percentages (APRs) you have provided. These reflect both the cost of the loan and the interest rate. Hence, they are often a better guide to value for money
Developing your own home isn't particularly scary. But it is serious business. So do your homework and make sure you are making the right decision about your personal finances.
Review your options for home admission (March 10, 2021).
How Much Can You Borrow From Your Home?
Don't imagine being able to withdraw all of the equity that you have in your home.
You may find a lender who is a little more flexible, but most want you to keep 20% of your property's value as equity. This means that you can typically only borrow 80% of the value of your home, including the amount you already owe on your existing mortgage.
Let's look at the example we used earlier:
Home Value: $ 200,000 You can borrow up to 80% of this: $ 160,000 ($ 200,000 x 80% = $ 160,000) Existing mortgage balance: $ 100,000 Maximum equity you can borrow: $ 60,000 ($ 160,000 – $ 100,000)
The maximum amount you can borrow compared to the value of your home is usually expressed as the maximum loan-to-value ratio, or LTV.
With that in mind, the maximum LTV for most withdrawal refinancing loans is 80%.
Lenders have this rule in order to lower the risk of borrower default. But it also contributes to your overall financial health.
Should You Use Your Home Equity To Borrow?
It is up to you to decide what to borrow and spend on your home. However, most financial advisors caution against borrowing to extend an unsustainable lifestyle or to indulge in personal whims.
For example, using home equity to fund a vacation, wedding, or other one-off expense with no return on investment is generally considered a bad move.
It is one thing to put your home at risk for a rare emergency that jeopardizes your financial security and quite another to do it for luxury purchases.
On the flip side, using your home equity to get your life going again by consolidating expensive, runaway debt – provided you've consulted a certified financial advisor first, is often very smart.
Many people also use home equity for home renovations that add value to their home. This can benefit you in the long run by making a higher profit when you eventually sell.
The most important consideration that you should take into account when borrowing for home loans is that your home will be used as collateral.
So if you can't repay the loan – for example, if you go into debt again and can't afford monthly mortgage payments – you face foreclosure.
This underscores the importance of using home equity only when you need it and using the money for purposes that improve your overall financial situation.
What is negative equity?
Most homeowners will experience an increase in their equity over time and will pay off their mortgages and house prices will go up.
However, sometimes property prices fall either across the country or in a local property market. When house prices fall sufficiently, a homeowner can owe more on their mortgage than the home is worth.
In this case, a loan is called “negative equity” or “underwater”.
For example, suppose you bought a home for $ 350,000 and your current mortgage balance is $ 300,000. If the value of this home falls to $ 275,000, you now owe $ 25,000 more than the home is worth.
These can be difficult times for homeowners. But luckily, they're relatively rare and usually short. Here is a graph that shows real estate price trends since 1960:
Source: FRED, Federal Reserve Bank of St. Louis
When you find yourself in negative equity, there are a number of utility programs that can help you refinance into a cheaper mortgage and get your finances back on track.
For more information on mortgage relief refinancing programs, click here.
Home FAQ
What does it mean to have equity in your home?
Your home equity is that part of the value of your home that you don't owe a mortgage lender. You build equity as you pay off your mortgage and as the value of your home increases. If you have enough equity, you may be able to borrow at a low interest rate.
What if you pull equity out of your home?
When you deprive your home equity, you increase the debt secured by your home. You may have to pay higher monthly mortgage payments or an additional monthly "second mortgage" payment. However, you get a lump sum or a line of credit that you can spend as you wish.
What is a Good Amount of Equity in Your Home?
The more home equity you have, the better. Equity increases all of your wealth and allows you to use your home as a financial safety net. 20% equity is an important benchmark as it allows you to frequently cancel your personal mortgage insurance (PMI) or refinance it at a lower interest rate. You typically need well over 20% if you want to cash out home equity.
How do you lose equity in your home?
There are three ways to "lose" equity: 1) borrow more credit on the home (for example, with a cash out refinance or a second mortgage); 2) you fall behind with mortgage payments; 3) The value of your home is going down.
Do you have equity when your home is paid off?
You bet! You have 100% equity. If you sell, you keep all of the proceeds (minus closing costs). You can also borrow against this equity, but this creates a new "lien" which means your home can still be foreclosed if you don't repay the loan.
How much equity can I pay out?
Most lenders want you to keep 20% of your home's value as equity. This is typically how you can take out 80% of your home's current market value. However, this is the maximum on all of your secured loans, so your existing mortgages are also included.
How Much Equity Should I Have in My Home Before Selling?
There is no rule for this. Some homeowners sell with little or no equity. However, if you have enough equity to pay a 20% down payment on your new home, you should be able to avoid mortgage insurance.
How do I know if I have 20% equity in my home?
Most people can get an idea of the value of their home by researching online and calling a friend of their real estate agent. Subtract your current mortgage balance from this and that is your equity. You may also be able to get a quote by contacting your mortgage loan service provider (the company you are making payments to).
What's the Best Way to Cash Out Home Equity?
It depends on your needs. For some, it's a payout refinance. For others, it's a home equity loan or HELOC. Make sure you choose the correct one by reading the information above and clicking the links to access more details.
Do you qualify to have your equity paid out?
Home equity can be a great way to fund home improvement, debt consolidation, and other large expenses. And today's low interest rates make home rental more affordable.
However, you must be eligible to take out a new loan against the value of your home. Typically, you will need well over 20% equity and good credit for the payout.
A mortgage lender can tell you if you are eligible for home equity withdrawals and how much you can borrow. You can check your eligibility here.
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