Home equity build-up is undoubtedly one of the most beneficial aspects of home ownership. In fact, The Federal Reserve reported in a recent study that homeowners accumulate 40 times more wealth than renters. In this article, we share some of our most significant findings about the use of home equity to see how you can benefit from this asset.
What is home equity?
In the simplest terms, home equity is the difference between the market value of your home and the balance of any liens against the property. Liens can include mortgages, tax liens, and any other debts you may owe where you used your home as collateral.
Elements that impact home equity
Equity in your home fluctuates over time. It is not necessarily a straight line in the upward direction. Here is a list of factors that will influence the equity in your home:
Mortgage balance reduction
Making regular payments is the easiest way to build equity. Additionally, making extra payments, such as bi-weekly payments, can accelerate loan balance reduction and increase your home’s equity. With that said, it may not make financial sense to make bi-weekly payments or pay off your mortgage early if current prevailing interest rates are higher than your mortgage interest rate — it’s outside the scope of this article, but if you can get a better market return by investing your funds vs. making bi-weekly payments, you may want to consider that route.
Local real estate market
The value of your home, and by extension, the equity in your home, is based on what other similar properties in your neighborhood and geographic area are selling for. As values go up, so does your equity. Conversely, if values go down, your equity will also go down.
Upkeep and Improvements
Homeowners who maintain or improve their homes improve the value of their property and therefore end up with more equity than their neighbors.
While some elements may be out of your control, you can still actively increase your home equity. Homeowners excel at improving their equity position by being strategic about their home’s condition and upkeep.
Calculating equity
The easiest way to calculate your home equity is to let House Numbers do it for you! Sign up today – it’s free!
The first thing you need to do is get the current value of your home. Using our handy home valuation tool that’s also used by actual mortgage lenders, you can find out how much your home is worth. Other home value tools are available, such as Zillow and Realtor, which can also help you get an idea of the value of your property.
Secondly, calculate the total of any liens against your home. This includes the amount you still owe on your primary mortgage and any secondary loans on the property, like HELOCs, or home equity loans.
Finally, subtract the total amount of the liens from the value of your home, and that’s your equity. The unique thing about House Numbers is that we update your home equity every month as you pay down your mortgage and your home value changes – so, you always have the most current info!
Reasons to tap into your home equity
Now that we’ve touched on the value of having equity in your home and the value and benefits of having equity, let’s go over some strategies you can use to improve your finances using your home equity.
Debt consolidation
Consolidating high-interest debt, like credit cards or personal loans, into a much lower rate is one of the most common uses of home equity. In this process, you pay off that high interest debt using your home equity, which you can borrow at a lower cost. Debt consolidation can save you thousands of dollars a year and relieve financial stress.
If you, like many homeowners who refinanced in the last few years, have a mortgage rate in the 3% – 5% range, a mortgage refinance is not attractive at the current, higher rates. In that case, you should still consider using a second mortgage (HELOC, home equity loan, etc) or home equity investment to consolidate your debt. Not only will you save money on interest, you’ll likely be able to lower your total monthly debt payments.
Home improvements
Over time, properties age, components deteriorate due to wear and tear, and remodeling becomes a necessity. Improving your home is also a great way to improve your quality of life or enable you to age in place as you get a bit older.
Using the equity in your home to improve its condition is a sensible and practical way of using your home because it is an investment that normally increases your home’s value.
Emergency funds
Being prepared for an emergency is a vital part of prudent financial planning. Yet, 57% of Americans can’t afford a $1,000 emergency expense, according to recent studies. That is a startling statistic and one that homeowners can avoid by using their equity as a source of liquidity. You will want to keep an eye on your monthly debt payments but, for many families, having the extra cash available for an emergency gives them the peace of mind when living a financially-balanced lifestyle.
Aging in place
Millions of homeowners nationwide have or will soon reach the age of 65. In fact, according to the census bureau, 10,000 people a day turn 65 in America. Considering that the homeownership rate is approximately 65%, we can see that people need to plan for those years when they may need special accommodations. Rather than go into a retirement or nursing home, many seniors prefer to stay in their homes, their neighborhoods, where they feel comfortable.
Making use of home equity at this stage of life is not only prudent but often a necessity for many. There are special programs and strategies, like reverse mortgages and home equity investments, that can help seniors gain financial independence through this stage of their lives.
How not to use your home equity
If your goal is to be financially secure and mortgage-free, you must be prudent in managing your equity. Home equity is an investment. So, it’s best not to tap into your equity to pay for a lifestyle that exceeds your income, or to buy fancy cars, recreational toys, or lavish vacations.
Accessing Home Equity
So far, I’ve laid out the “what’ and the “why” of home equity. Now, let’s go over how you can access your home equity. We recently blogged about the different ways to access your home equity so we recommend you read that if you want to learn more. But, here is a quick overview:
- Home equity loan: you receive a one-time, lump sum payment, typically with a fixed interest rate.
- Home equity line of credit: also known as a HELOC, this is a line of credit against your home, which you can use as needed and typically has a variable interest rate.
- Cash-out refinance: usually more popular when interest rates are dropping, a cash-out refi replaces your primary mortgage, while also taking money out of your residence, usually with a 30-year fixed interest rate.
- Reverse mortgage: for homeowners older than 55 years old, you receive cash up-front or as income over time in exchange for equity in your home. Your current mortgage is paid off, and there’s no monthly payments. The bank gets paid back when you move out permanently or pass away.
- Home equity investments: also known as an HEI, this is when a private investor gives you cash in exchange for some of your equity and future appreciation of your home.
If you want to learn about the pros and cons of each, read our recent article on the topic.
Risks and Considerations When Using Your Equity
Using your home equity is not without its possible risks although, if done prudently, it is a valuable resource for your financial security and planning. Here is what you may need to be cautious of when using your equity:
Overborrowing
There are cases where you may be overborrowing unnecessarily. Although rates and terms on equity loans can be more favorable than unsecured loans, you still need to exercise caution on how much you borrow from your equity.
Declining home values
Home values decline from time to time. Plan accordingly to make sure you leave room for reasonable fluctuations in your home value without being “under water.”
Interest rate fluctuations
If you access your equity through a HELOC, make sure you are fully aware of the maximum rate and can afford the payment if it increases.
Understanding the basics of home equity
While I’ve covered many aspects of equity, it is imperative to recognize that everyone’s financial situation is different. Using home equity responsibly is ultimately a choice that the homeowner has to make.
As you navigate the world of home equity and explore the various ways to make the most of this valuable asset, remember that personalized guidance can make all the difference. The team of professionals at House Numbers is here to help you make informed decisions tailored to your unique financial situation. Don’t hesitate to reach out and discover how we can empower you to unlock your home equity’s full potential.
