Why Home Equity Matters – Forbes Advisor

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Your home equity – the current value of your home minus your mortgage balance – is important because it helps you build wealth. When you have equity in your home, it’s a resource you can borrow against to improve your property or pay off other high-interest debt. However, it is also volatile because home values ​​change constantly, sometimes dramatically. To get a home equity loan, you will need a stable income and good credit.

Home equity is an important component of household wealth for many people. This is especially true for black and Hispanic households, which “have experienced disproportionate gains in real estate wealth over the past decade,” according to the Federal Reserve.

At the end of 2019, about 28% of the wealth of Hispanic families and 20% of the wealth of black families came from home equity, compared to about 16% for white families. The percentages are so high partly because the housing market has been strong over the past decade, and partly because black and Hispanic families, who overall have less wealth than White and Asian families, have a percentage higher of their wealth tied to the house. equity.

What is home equity?

The equity in your home is the difference between the current market value of your home and your mortgage balance; it can be positive or negative. When positive, this is an asset you can tap into, typically up to 80% of your home’s value, which can be critical when you have few other assets (stocks and funds). emergency cash, for example). It’s also a cushion against a market downturn that might otherwise prevent you from selling your home.

When you have negative equity, selling your home isn’t enough to pay off your mortgage. This is how many homeowners were forced to short sell or foreclose during the Great Recession.

How home equity works

The equity in your home depends on two things: your mortgage principal and the local real estate market. In a perfect world, as you pay off your mortgage, your equity would increase. This is because the value of your home minus your mortgage balance equals your equity. However, this is not the case if the value of your home goes down.

Factors beyond your control affect the attractiveness of homes in your area and influence the value of your property, which play a role in determining whether your equity decreases, stabilizes, or increases over time.

In many markets, the housing shortage has driven up home prices (values) in recent years: think San Francisco, Los Angeles, Denver, and Seattle. Nationally, the housing supply – the number of homes available for sale – is at an all-time low, according to the National Association Realtors.

But if you live in a city with a declining population and aging housing, your home’s value may be falling. Even when you pay off your mortgage, the equity in your home can decline.

While the state of the housing market is not in your hands, there is one thing you can do to try and preserve the value of your home: maintenance. A clean, comfortable, well-maintained home will always be more desirable than another (except for some real estate investors who prefer neglected properties).

How You Build Home Equity

There are two ways you can increase your home equity:

  • Appreciation of the price of the house. The market value of your home – the amount you could sell it for – is increasing.
  • Reduction of mortgage capital. As you pay off your mortgage principal, your equity increases, as long as your home’s value is stable or increasing.

The longer your mortgage, the faster you build equity with each monthly payment. If you look at a mortgage amortization schedule, you’ll find that the bulk of your payment is spent on interest at the start of your loan term. With each payment, you owe less money and earn less interest. More of your next payment is then allocated to your principal.

Calculating Home Equity

Follow these four steps to calculate your home equity:

  1. Find the estimated market value of your home using an online tool or by looking at recent sales prices of comparable properties.
  2. Check your last mortgage statement to see how much principal you owe.
  3. Subtract your mortgage balance from the value of your home with this formula:

    Home Value – Mortgage Balance = Home Equity Amount

  4. If you want to know the percentage of equity in your home, and not just the amount of equity in your home, use this formula:

(Home value – Mortgage balance) / Home value = Percentage of home equity

Here are some examples to help you understand math.

How to use the equity in your home

Home equity is a valuable resource. If you borrow against him, you can technically use the money however you want. However, it’s common to use it for larger expenses like home renovations, graduate school, debt consolidation, or moving.

HELOCs

A Home Equity Line of Credit (HELOC) gives you access to 80-85% of the value of your home. Instead of receiving a lump sum, you can use a line of credit as needed. You will only have to pay interest on the amount you borrow and the interest rates are variable.

Home equity loan

Unlike a line of credit, a home equity loan allows you to receive up to 85% of your home’s value as a lump sum payment. You will pay interest on the full amount and have to repay the loan in five to 30 years, depending on the specific terms of your loan. If you know how much to borrow and want the security of a fixed interest rate, a home equity loan is a good choice.

Refinancing of collection

Refinancing with cash can be a good way to access your home equity when you want to refinance your existing mortgage for a lower interest rate or access additional financing for other expenses. It allows you to borrow up to 80% of the value of your home and replaces your current mortgage with a new, larger mortgage. The money you receive is the difference between your old and your new mortgage.

Reverse mortgage

Homeowners who are at least 62 years old and have little or no mortgage balances can use a reverse mortgage. These mortgages allow you to borrow against your considerable equity and secure a loan that you may never pay off on your own. Instead, when you move out or pass away, your heirs will list and sell the property to pay off the reverse mortgage amount.

Down payment on a new house

Some people buy a cheaper home to start with, then sell it to upgrade when their finances are stronger. The equity you build up over the years of home ownership can become the down payment for your next home when you sell.

Sell ​​and return to lease

After gaining ownership, some people decide it’s not worth it. The time and money required to maintain a home can be considerable. Selling allows you to cash in all of your equity and use it as you see fit.

Benefits of using home equity

  • Getting a loan with your home allows you to get a low interest rate.
  • Interest rates are low compared to other forms of borrowing.
  • You can use the money for almost any purpose.
  • Interest may be tax deductible if you use itemized deductions.
  • You can usually borrow up to 85% of the value of your home, depending on your total equity.

Disadvantages of using home equity

  • You can lose your home if you don’t pay off a home equity loan.
  • You will pay loan fees and interest to dip into your equity.
  • It gets you back on the road to debt free home ownership.
  • Your savings by detailing the interest on home equity loans can be minimal.
  • You may not be able to dip into your equity when you need it most, as loan eligibility depends on market conditions, your income and your credit.

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