What is home equity?
Homeowners who slowly but surely pay off their mortgage not only build good standing with creditors, but also steadily increase their portion of ownership in the property. This is known as building equity and offers one of the strongest financial benefits of investing in real estate.
A major advantage to buying a home is the opportunity to build wealth over time. For homeowners, that wealth is defined as the amount of equity they have in their home.
What is home equity?
Equity outlines how much of your home you actually own relative to your lender’s stake in the property. This portion of ownership is first established through a down payment and gradually increases as you pay off the remaining balance on your mortgage. Any rise in the value of your property also impacts your share of equity.
For example, if you contribute a 20% down payment and pay off 30% of your mortgage loan, you should have 50% equity in the home. The remaining 50% is held by the lender as collateral for the mortgage loan. By paying off your mortgage through scheduled monthly payments, you slowly chip away at the lender’s stake in the property while expanding on your own.
Real estate is typically viewed as a safe investment as properties tend to gain value over time. This also benefits homeowners as they aim to build on their equity. As ahome’s value increases, and the remaining loan balance decreases with each monthly payment, your share in equity grows.
Let’s say you buy a home for $100,000 and you owe $50,000 on your mortgage, giving you 50% equity in the home. If that home’s value doubles in value to $200,000, your loan balance of $50,000 does not change. Your equity in the home, however, would increase from 50% to 75%.
In addition to establishing the homeowner’s portion of ownership in the property, equity can be leveraged to consolidate other debts, finance home renovations or establish new lines of credit. Gaining equity over time grants you with more financial resources and flexibility to take on new investment opportunities later in life.
How do I calculate home equity?
To calculate your home equity, you’ll need to do some research on the value of your home. While a professional appraiser can provide an official estimate, homeowners can gauge the value of their property by reviewing local market trends and the sales price of similar homes.
Once you have a good idea of what your home is worth, you can take that estimate and subtract the remaining balance on your mortgage. The number you’re left with is the approximate amount of equity you have in your home. If you estimate your home’s value at $200,000 and your remaining mortgage balance is $70,000, the amount of equity you have is $130,000, or 65%.
Equity is gained with each monthly mortgage payment, as a portion of your payment goes directly to principal. The amount paid to principal increases every month as you pay your mortgage. If you are looking to gain equity at a faster rate, paying additional principal with your normal monthly payment will help you increase your equity position.
When looking to refinance or leverage your equity with a lender, a rough estimation will not suffice. Your lender will need an official evaluation of your home value and will require you to schedule an appraisal.
An appraiser is a certified professional who evaluates a home’s value and builds a report based on multiple factors. These reports, or home appraisals, involve a thorough review of the property's interior and exterior, as well as any adjoining structures or additional features on the property. The appraiser will consider the property square footage, quality of construction, number of rooms and bathrooms when determining the property value This information helps the appraiser compare your home to similar sold homes in your market area to determine an appraised value. Once the appraisal is complete, the submitted report provides the value, which is used by the lender to determine the equity available for a refinance of the property.
Why is equity important?
Building equity in your home might take a long time, but the benefits of owning real estate are well worth the investment.
Unlike other large assets, property value tends to steadily increase after a purchase. Vehicles and business equipment, on the other hand, lose value the moment they are first used. As a reliable economic strategy, building home equity has become one of the most common methods for establishing wealth and ensuring a financially secure future.
Once you own a sizable portion of equity, you may be able to refinance or take a second mortgage to borrow against the equity you have accumulated with a refinance or home equity loan.
You can leverage that wealth into other purchases or investments. Home renovations, university tuition and additional lines of credit can all be financed by leveraging equity into an additional loan from a lender.
What is a home equity loan?
Also known as a second mortgage, home equity loans provide a useful option for homeowners looking to finance large expenses.
Typically second mortgages are used to take equity out of the property to use for home renovations, pay for college tuition, or provide cash for a down payment on a home. These loans are designed to help you leverage the equity you have built in your property.
When securing a home equity loan, the lender will require an appraisal to calculate how much equity you possess in the property. The amount of equity you have determines whether you’re eligible and how much you’ll be able to borrow.
Since lenders will be using your existing home equity as collateral, a second mortgage would be placed on your home. Similar to your initial mortgage on the property, this lien also gives lenders the right to reclaim the property if scheduled payments become past due.
In addition to receiving these funds in a lump sum, borrowers also have the option to open a home equity line of credit (HELOC). A HELOC is a line of credit secured against your home. Similar to a credit card, you can borrow against available funds as needed. Generally, HELOCs require interest only payments on only the outstanding balance for a set period established by the lender at closing.
Building home equity throughout the life of a mortgage is one of the greatest advantages of owning a home. Millions of people have expanded their personal wealth by reaping the long-term rewards of homeownership.
Whether you’re looking to expand your investments, open a line of credit, or save for a rainy day, home equity can help you pursue your financial goals. For an official estimate of your current home equity status, start by speaking with a loan officer about scheduling an appraisal for your home.
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