Owning a home is one of the best ways to build wealth over time. As you continue to make your mortgage payments, you build something called home equity—an often-overlooked resource that can unlock financial opportunities. But what exactly is home equity, and how can it benefit you? In this post, we’ll break down everything you need to know about home equity, including how to calculate it, the difference between a home equity loan and a home equity line, and how to use it to your advantage.
What Is Home Equity?
Home equity is the difference between your home’s current market value and the amount you still owe on your existing mortgage. In simpler terms, it’s the portion of your home that you truly own, not counting what you still need to pay back to your lender.
For example, if your home is worth $300,000 and your current mortgage balance is $200,000, you have $100,000 in home equity. Over time, as you pay off your mortgage and your property value increases, your home’s equity grows.
How to Calculate Your Home’s Equity
To calculate how much equity you have, subtract your outstanding balance from your home’s appraised value. It looks something like this:
Home Equity=Appraised Value of Home−Current Mortgage Balance
The current market value of your home plays a crucial role here. You can estimate this based on recent sales in your neighborhood or by getting a formal appraisal. Keep in mind that fluctuating property values can impact the exact amount of equity you have at any given time.
Building Equity in Your Home
Every time you make a mortgage payment, a portion of that payment goes toward the principal balance, increasing your equity. The more payments you make, the more you chip away at the amount you owe. Additionally, if your home appreciates in value, your equity will increase even if you’re still paying off your loan.
For example, if property values in your neighborhood rise and your home is now worth $350,000 instead of $300,000, your equity increases without you doing anything extra. This combination of making payments and potential appreciation helps you steadily build wealth.
Home Equity Loans vs. Home Equity Line of Credit (HELOC)
Once you’ve built enough equity, you can borrow against it to access funds for various needs. Two popular options are home equity loans and home equity lines of credit (HELOC). Let’s look at the differences between the two.
Home Equity Loan
A home equity loan is a second mortgage that allows you to borrow a lump sum of money, which you repay over a fixed period. These loans typically come with a fixed interest rate, meaning your monthly payments stay the same for the entire term of the loan.
Home equity loans are a good option if you need to borrow money for a one-time expense, such as home renovations or consolidating debt. Because of the fixed rate, you can plan your payments more easily without worrying about market fluctuations.
Home Equity Line of Credit (HELOC)
A HELOC works more like a credit card. Instead of receiving a lump sum, you’re given access to a maximum amount of money that you can borrow as needed during the draw period. During this time, you make interest-only payments on what you’ve borrowed. After the draw period ends, you enter the repayment period, where you start paying back the principal along with the interest.
HELOCs typically come with a variable rate, meaning your interest rate can fluctuate over time. However, they offer flexibility, making them ideal for ongoing projects or expenses. You can borrow, pay back, and borrow again as needed during the draw period, offering a revolving line of credit.
Cash-Out Refinance: Another Way to Access Your Equity
Another option for accessing your home’s equity is a cash-out refinance. With this option, you replace your current mortgage with a new loan that is larger than what you currently owe. The difference between the two amounts is given to you in cash.
For example, if your home is worth $400,000 and you owe $250,000, you could refinance for $300,000 and take the extra $50,000 as cash. Just keep in mind that this increases the amount you owe on your mortgage, so your monthly payments will likely increase as well.
What Can You Use Home Equity Borrowing For?
One of the biggest benefits of building equity in your home is the ability to borrow against it when needed. Homeowners often use home equity loans or HELOCs for the following purposes:
- Home improvements or renovations
- Consolidating high-interest debt
- Paying for college tuition
- Medical expenses
- Starting a business
- Emergency expenses
Before borrowing against your home’s equity, consider your long-term financial goals. Home equity borrowing can be a powerful tool, but it’s essential to make sure you’re borrowing for the right reasons and have a solid plan to repay the loan.
The Benefits of Home Equity Borrowing
There are several advantages to borrowing against your home’s equity, including:
– Lower interest rates: Home equity loans and HELOCs often have lower interest rates than personal loans or credit cards because your home serves as collateral.
– Tax deductible interest: In some cases, the interest you pay on a home equity loan or HELOC may be tax deductible if the funds are used for home improvements. Check with a tax advisor to understand the specific rules.
– Flexible options: With a HELOC, you can borrow and repay money as needed during the draw period, offering flexibility for ongoing expenses.
However, it’s important to remember that using your home as collateral means that failure to repay the loan could result in foreclosure.
How Much Equity Do You Need to Borrow?
Lenders typically require that you have at least 15-20% equity in your home to qualify for a home equity loan or HELOC. To calculate this, take your home’s current market value and subtract the amount you owe on your mortgage. This will give you a rough estimate of how much equity you have.
For example, if your home is worth $300,000 and you owe $200,000, you have $100,000 in equity, which is roughly 33%. Most lenders will let you borrow up to 80-85% of your home’s equity, so in this case, you might be able to borrow up to $80,000.
Factors to Consider Before Borrowing
Before taking out a home equity loan or HELOC, there are several important factors to consider:
– Fees and closing costs: Some loans come with annual fees, closing costs, and account opening fees. Make sure to factor these into your decision.
– Interest rates: Depending on the fixed or variable rate, your payments could change over time. A fixed rate offers predictability, while a variable rate may fluctuate based on market conditions.
– Repayment terms: Understand the repayment period and whether you can manage the monthly payments comfortably.
– Current market conditions: If property values drop, you could end up owing more on your loan than your home is worth. Make sure to account for potential market fluctuations.
Is Home Equity Borrowing Right for You?
Home equity can be a powerful tool in your personal finance strategy, offering access to low-interest loans and helping you build wealth over time. Whether you’re considering a home equity loan, a HELOC, or a cash-out refinance, it’s essential to weigh the pros and cons and understand the long-term impact on your finances.
By keeping an eye on your home’s market value and staying on top of your mortgage payments, you can effectively leverage your home’s equity to achieve your financial goals.
If you’re considering tapping into your home’s equity in Augusta, our team at Peter Larson Homes is here to help you make informed decisions. Contact us today to learn more!