Your home is probably the most valuable asset you will ever have. Whether you own your home or have investment property, real estate is typically a good investment because property values historically increase over time. From the moment you buy a house, you are building equity in a home—equity that can be converted into cash.
If you are not familiar with the term home equity, it is the difference between the value of your home and what you owe on that home. Home equity increases as the property value increases and the amount you owe on your mortgage decreases.
Having home equity gives you an asset that you can use when you need it. If you have a medical emergency or need to cover a large expense at the last minute, you can convert that equity into cash. You may also want to use your home equity for improvements to increase the value of your home, or you may want to include it as part of your retirement strategy.
Building Equity in Your Home
So how does home equity really work? The formula is fairly simple: Start with the amount you owe on your house, typically your mortgage. Then subtract that amount from the current market value of your home.
For example, if you purchased a home valued at $300,000 with 20%, or $60,000, as a down payment, then your mortgage would be $240,000, which means your home equity would be 20% of the home value. If the property value increases to $400,000, then you still have your original $60,000 investment, but your home equity would increase to $160,000 ($400,000 value minus $240,000 owed), or 40% of the home value. Lenders will usually allow you to borrow up to 80% of the value of your property, including the mortgage and home equity loans.
There are a number of ways to build home equity, including:
- Prepaying your mortgage: The larger the down payment, the more home equity you will have. You can also accelerate your mortgage payments to increase your equity. If you want to get more value out of your home faster, you could consider a 15-year mortgage.
- Increasing your property value: There are a few ways you can increase the value of your home. First, be sure to maintain your home and stay up on repairs so it keeps its market value. You could also consider remodeling part of your home, but the remodel needs to add value, such as an additional bathroom or a modernized kitchen. If you plan to remodel, make sure that the cost of the project is less than the anticipated value added to the home.
- Being patient: Building equity in a home just takes time. Homebuying is not a get-rich-quick strategy. Making money flipping houses is risky, but if you can wait, then your home will likely increase in value over time.
What Do You Do with Home Equity?
If you have equity in your home, you can convert it into a home equity loan or a home equity line of credit (HELOC), or you can refinance your current mortgage and cash out the equity. You can use the money for any number of things, such as:
- Buying a second home as a vacation home or income property
- Paying for college tuition
- Debt consolidation
- Retirement investments
You want to be cautious about how you tap into your home equity. Compare interest rates. If you plan to use a HELOC for debt consolidation, for example, the interest rate on the HELOC should be lower than the interest rate on your existing debt; otherwise, you aren’t saving money.
The same is true for tuition: Is the home loan interest rate lower than the rate on a student loan? Chances are that you will get a lower interest rate with a home equity loan, and you may have more time to repay it, which means your monthly payments may be lower.
Of course, home equity financing does have risks. You are using your home as collateral, so if you fail to make the payments, the lender can foreclose your home. When you decide to borrow against your home equity, be sure the additional payments fit within your household budget.
If you have started to build equity in your home, maybe it’s time to reassess your financial strategy. Can you put that money to better use—by paying off credit card debt, for example? Are you thinking of starting a business and in need of seed capital?
Consider whether refinancing your home or setting up a HELOC would help you while fitting into your budget. If you have home equity, don’t feel pressured to use it. Chances are that your home will continue to appreciate in value, and your equity will continue to grow.
If you are thinking about tapping into the equity in your house, why not talk to one of the financial advisors at iQ Credit Union? We are experts at home loans and partner with our members to help them find the best way to leverage the value of their homes.
We can help you determine the best way to include your home as part of your financial future. Why not start with our Mortgage Paperwork Checklist and stop in at the nearest iQ Credit Union branch?