What Is Equity And How Does It Benefit You?
There’s a common belief that becoming a homeowner can help you build wealth through home equity. Think of it as your vested interest in a property – the more you put in, the more you get out.
So, what is equity? In a nutshell, it’s the percentage of your home that you “own” – the portion that you still owe on the mortgage isn’t yours until you pay more of it down. It can be one of your largest and most valuable assets. If you’re strategic about it, you can use this asset later on to your advantage.
Yes, that means in order to tap into it, you need to know what home equity is, how it works and how you can use it to enhance your financial life.
Equity, in general, refers to the amount of money that’s split between parties if the asset is liquidated. In other words, home equity is the amount you have in your residence – typically based on a percentage of the overall value of the property. It’s the amount you own outright.
To calculate home equity, take the current value of your home and subtract it from what you still owe on your mortgage. Let’s say your house is currently valued at $350,000 and you put down a 15% down payment. In this case, you have $52,500 home equity. Even though you own the home, you only truly own 15% (or $52,500) of it.
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Is Home Equity Real Money?
Yes and no. Home equity is an asset and you can certainly tap into it using a few methods (more on this later). However, it’s not a liquid asset like what you have with a regular savings account or a taxable brokerage account, where you can access cash relatively quickly.
Instead, think of home equity as a long-term strategy of building your net worth – the money you put toward your mortgage is like putting cash into an account you can access directly. Unlike other types of other assets (like your vehicle), your home has the potential to appreciate in value, though that’s not guaranteed.
How Do You Build Home Equity?
Building asset in the form of home equity can help increase your net worth. There are two ways you can build home equity:
Pay down your loan: The more you pay down your mortgage, the more your equity goes up. Most mortgages are amortizing loans – payments go towards interest and the principal. The amount you pay will go toward more of the principal, helping you increase equity. If you have a different type of loan (such as a nonamortizing loan) you may need to make extra payments to increase home equity.
Increase home value: In some cases, your home equity automatically increases if your property increases in value. Perhaps your neighborhood is considered a booming area and homes have sold for more, or you’ve done some renovations that have considerably increased your home’s value.
Typically, the longer you stay in your home, the more home equity you can amass, though that’s dependent on how much money you put toward the mortgage principal. If you’re looking to access your home equity, you don’t need to sell your home, as described in more detail in the next section.
How Do I Use Home Equity?
If you’re wondering how to get equity from your home, there are several ways. Once you’ve built up significant equity (typically 20% or more), you can tap into it by taking out lump-sum or partial amounts.
Here are few main ways you access your home equity:
Borrow money against the equity: You can get cash and use it for almost any purpose with a home equity loan. As for what a home equity loan is, there are a couple different types – a lump-sum home equity loan or a home equity line of credit (HELOC) where you withdraw money when you need it up to a preapproved amount. Another option, called a cash-out refinance, is where you refinance your existing mortgage for one in a larger amount, and you get the difference in cash.
Each of these options have their advantages and risks, so make sure you do your research before filling out an application form.
Fund your golden years: If you want to stay in your home after you’re well into retirement and aren’t interested in passing on your property to heirs, then a reverse mortgage can be a great way to tap into home equity. This type of loan gives pays you monthly – you can use that income however you wish. The loan will be repaid when you or the principal homeowner no longer reside in the property. Be warned, these loans can be complicated, and you’ll have to meet certain requirements, so check the fine print.
Sell your home: When you decide to move, you can take the extra equity toward a new home. You might still have to take out a mortgage for the new place, but you can use your equity toward a larger down payment. Or, you can get cash if your new purchase is less than your current property.
Build Wealth With Home Equity
Building wealth with home equity is a long-term endeavor that could pay off once you continue to pay down your loan. There’s the option of home equity loans and getting cash if you sell the house. To get a loan, make sure you check your credit score – the higher it is, the more likely you’ll be approved with more favorable terms and rates. You’ll also need to know how much equity you have and show lenders you’re able to pay back the loan. Tools like RocketHQSM, and Quicken Loans’® mortgage calculators can take the guesswork out of many of these factors, helping you to tap into much needed home equity. Be sure to check out more about personal finances and credit resources in our learning center.
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