Home Equity: What It Is and How You Can Use It
Home equity is the difference between the value of your home and the current outstanding mortgage debt. Most lenders require you have a down payment of 10% to 20% of the home purchase price. At the time of purchase, that is the value of your home equity.
The amount of your home equity, however, changes over time as you make mortgage payments and the market value of your home increases or decreases. As you build more home equity, you may decide to access it to pay down other types of debt or finance home improvements. However, you need to understand how home equity works to see if this is the right financial move for you.
Why is Building Home Equity Important?
It’s important to build equity in your home because it can give you financial flexibility and access to home equity products. Homeowners have the opportunity to access the equity they have built in their home by taking out home equity loans or home equity lines of credit (HELOCs).
Both of these debt products allow homeowners to gain access to their home equity in exchange for cash, which they can use to pay off or consolidate credit card debt, go on vacation, pay college tuition, or renovate their home.
Home equity gives homeowners an additional source of funding and the financial flexibility they need. The amount homeowners can borrow, however, depends on the amount of home equity they currently have. You can learn more about the pros and cons of HELOCs here.
For many Americans, their home is their single largest asset. Building equity in your home is a way to build the value of your assets and increase your net worth. Your home is a unique type of asset because it not only gives you shelter but also creates wealth and financial security.
How to Build Home Equity
Building home equity over time is a simple process. Here’s how to do it:
Buy Your Home
To build home equity, you need to buy your home and quit renting. When you own your home, changes in real estate prices can help your equity increase over time. Under normal market conditions, home values appreciate every year. As the value of your home increases, so does the value of your home equity.
Consider an example in which you owe $200,000 on a home worth $250,000. Imagine that tomorrow, your home increases in value to $260,000. The value of your home equity increased from $50,000 to $60,000.
Any down payment you make when you first purchase your home also gives you equity.
Increase Your Mortgage Payments
Another way to build your home’s equity is by making payments toward your mortgage. Unless you have an interest-only mortgage, every monthly mortgage payment you make gets split between interest and your principal balance. The portion that pays down principal helps you build equity by decreasing your debt.
Unfortunately, at the beginning of your mortgage loan, only a small portion of your payment goes toward principal because most of the money is allocated toward interest. The portion of the payment that pays down principal gets a little bigger each month, though.
You can also make additional payments on your home loan to build equity faster. When you pay more than the monthly minimum, all of the extra money goes to your principal balance.
When you reduce your mortgage balance more quickly by making extra payments, the interest due the following month will be less. As a result, the portion of your next payment that goes to principal will be slightly larger. Every time you pay a little extra on your mortgage, you can increase the rate at which you build equity in your home.
Before you do this, you need to make sure your lender doesn’t impose any prepayment penalties for paying the loan off earlier than planned.
How to Use Home Equity
There are many ways you can tap into your home equity, but two of the most common approaches are a home equity loan or HELOC. Both allow you to borrow against the value of your house in exchange for cash. Here a few key ways you could use the equity you’ve built up.
Home remodels and upgrades can be expensive, especially if you need to make major changes to your house such as removing walls or putting in a new kitchen. Both home equity loans and HELOCs could give you the cash you need to fund a home remodel, but a home equity loan works best when you have a one-off project and need to borrow a set amount of money at once.
Meanwhile, a HELOC makes more sense if you’re doing ongoing renovations and need to borrow funds over time.
See the full article here: Home Equity: What It Is and How You Can Use It
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