Every homeowner needs to keep an eye on their home capital. This knowledge can empower you to use your own capital if you need it.
Keyword here need… We’ll guide you with a list of pros and cons below to help you decide if you should use your own equity.
What is equity?
Equity is calculated based on the current market value of your home minus your mortgage balance.
Let’s say your home is worth $ 200,000 and you still owe $ 150,000 on your mortgage. Your net worth is $ 50,000. If a buyer came to you today and offered $ 200,000, and then you turned around and paid off your mortgage, you would have $ 50,000 to deposit in your bank account.
Improving equity in your home is beneficial for several reasons:
- Increasing your total net worth
- Using the proceeds from the sale of your home to finance your next home
- Borrowing to renovate or renovate your home
Below we take a closer look at how you can determine the value of your home, how to increase it, and what you can do with it.
How does home equity work?
For most people, net worth is simply a number that they see as increasing (hopefully) or decreasing (hopefully not) monthly or annually.
Sunrise
Assuming the value of your home rises and you pay off your mortgage, you are creating equity in your home. It’s money that you can use if you want, but many people are happy to let their capital grow until they own a home for free and clean.
For those who don’t like the idea that their money is blocked, homeowners can use their home equity to open a HELOC (line of credit), which usually has a lower interest rate than a personal loan.
Connected: 6 factors to consider before using HELOC for your emergency fund
The fall
On the other hand, a house may have negative equity when its value declines and the buyer wants to sell it, but still owes more on the mortgage than the sale will bring.
The historical lesson of falling home equity
Think back to the Great Recession of 2008-2009 and how house prices plummeted. If the value of a $ 200,000 home falls to $ 150,000 but homeowners still have $ 170,000 in debt, they will be left with a $ 20,000 deficit. To sell their home, they needed to come up with an extra $ 20,000 to pay off their mortgage.
Job loss and other financial factors made this impossible for many people, so mortgage holders had no choice but to let the bank take back their homes and try to sell them to recoup their investment.
For people who were able to weather the fall in house prices, this was not a big problem. Of course, they couldn’t borrow their house, but they didn’t lose any real money either. Those who could not face a period of financial instability and even homelessness.
Over the past decade since then, we have seen an increase in house prices from year to year. But if you look back at historical house prices, you see a cyclical pattern in most markets: prices rise, fall, rise to their previous highs, and perhaps even exceed them before falling again.
How to calculate the net worth of your home
To find out how much capital you have accumulated in your home, follow these three simple steps:
Step 1
To find out the approximate value of your home, go to Zillow.com and enter your address. You will see that it shows your Zestimate, that is, what, according to their algorithm, your house is worth. Write this number down on a piece of paper. You can also check other real estate listing websites to compare and use the average of what all sites think your home is worth.
Step 2
Then find your most recent mortgage statement and write down the balance. For accuracy, subtract the mortgage payment you made this month.
Step 3
Subtract your mortgage balance (step 2) from the value of your home (step 1). Easy, right? This is the amount of home equity that you have.
How to build equity in your home
The most obvious way to raise capital in your home is to pay off your mortgage. Each monthly payment applied to the principal is another dollar added to your balance.
In the early years of your mortgage, most of your monthly payment will go towards interest, so your capital will grow slowly.
To expedite this, and as long as your lender does not have a prepayment penalty, you can make additional mortgage payments and indicate that you want the additional payment to be directed towards the principal.
The amount of your down payment also affects the amount of your capital. The more money you put into your home in advance, the more you have left for the future. Hopefully, over time, your home will become more valuable, and this will increase your stake in it.
Improving your property can also help you increase capital. Adding a terrace, upgrading your HVAC system, or renovating a badly worn roof can add value to your home.
Consider an example of a purchase price of $ 200,000. Let’s say you paid off your mortgage up to $ 150,000, but now your home is worth $ 300,000. In this scenario, you now have $ 150,000 in your account. Conversely, if the value falls below $ 150,000, you have a negative balance.
If your area is experiencing significant demographic changes or crime rates start to rise, the value of your home could drop, leading to a decrease in your capital.
Before buying a home, study trends and take a close look at your surroundings so you don’t end up in an area where property values are declining.
How can I use my equity capital?
Get rid of PMI
The 20% down payment when buying a home gives you enough home equity to avoid paying PMI (Private Mortgage Insurance).
If you already pay for PMI or don’t have a 20% down payment, consider making additional payments towards your mortgage principal.
Once you have created 20% of your home equity, read this article on How to get rid of PMI in order to take the next steps.
Increase your capital
Your net worth may include equity, so if you buy another property or get a loan for something, you can calculate the amount of equity as an asset.
Connected: How and why to track your capital
HELOC vs home equity loan
Another way to use it is to get a HELOC, which is a revolving line of credit for your home. Using HELOC, you can borrow from him as needed and only pay interest on the amount you use.
Many banks will not allow you to borrow from home equity until you have at least 20%, and even if you have 35% of the capital, the bank usually requires you to leave at least 15-20%, which means that you can only get a loan. approval for 15% of the capital.
Likewise, you can get a home equity loan as a lump sum and repay it in installments.
In addition to paying interest, HELOC and home equity loans may incur additional fees. Here is a list of costs to ask about when contacting your lender for a HELOC or home equity loan.
Connected: Can you really pay off your mortgage ahead of time with HELOC?
Refinancing payment
You can also do cash refinancing, which is popular with real estate investors. This process allows you to refinance your home, preferably at a lower interest rate, and still cash out the capital. Your equity position will be minimal, but you will have a little money to pay off debt, make a necessary purchase or invest in your next property.
Sell your house
Finally, if you don’t want to be a homeowner, there is no shame in selling and becoming a landlord. You can sell your home and use the capital just like any other cash. Pay off debts, buy something new, travel or invest in the future. And if you’re ready to move on, you can sell your home and use the equity as a down payment for your next primary residence.
Pros and Cons of Using Your Home Equity
As with most things in life, there are certain pros and cons to using home equity, and here are some of them for you to consider.
pros
- Get rid of PMI. You can make additional payments on your mortgage principal to increase your equity and ultimately get rid of PMI. A 20% down payment on future home purchases will help you avoid PMI.
- You are eligible for a lower interest rate on a line of credit or home equity loan. The interest rate may be better than what you would get on an individual loan. In addition, the application process can be faster and easier if the borrower is already a client of the bank.
- With HELOC, you can only use what you need. Let’s say you are approved for a $ 10,000 home equity line of credit, but right now you only need to use $ 1,000 for debt consolidation. After a few months, you might need $ 8,000 and that’s okay too. As long as you have a good reputation, you can access this money over and over again with HELOC.
- You can improve your credit score. Your home loan will add data to your credit report and you can see how your credit score will go up if you make your monthly payment on time.
Minuses
- Loans against your home equity are not free. A line of credit or loan may include fees, including processing and appraisal fees in addition to the interest rate.
- In the “worst case”, you risk losing your home if you borrowed more than you can pay each month. To reduce the risk of this, always be conservative in what you borrow.
- It’s easy to think of equity as free money and then use it for other purposes. Just like a credit card, you must pay off the loan. Many people erased their HELOC because of frivolous things and then regretted it. Make sure you need money before borrowing it, and limit yourself to spending the loan on something that will add value to your home.
Bottom line
Equity is critical if you want to access money for short term loans. How much home equity you start depends on your down payment and how actively you pay off your mortgage, but remember that there are also factors beyond your control.
When the housing market drops, you can lose capital, but it won’t go away forever if you don’t have to sell your home during this time. Responsible borrowing from home equity and maintaining a reserve fund are essential to weather any financial storms that come your way.