Your home may be your castle, but it’s also something else: a way to build a little bit of wealth while you forgo the experience of renting from someone else. Although you’re responsible for the upkeep of your house once the mortgage closes, it’s not for nothing. With each payment, with each passing day, you may be building something valuable: home equity.
What Is Home Equity?
Home equity, simply put, is how much your home is worth beyond what you owe on it. For example, if your home is worth $350,000 and you only owe $300,000, you have $50,000, or about 14%, in home equity. There are different ways to come at these figures and to make them work better for you.
“The value of your home is typically determined by comparable sales of similar properties in your area,” says Zach Miller, loan officer at Gershman Mortgage in Springfield, Missouri. “You may have an idea of this by watching other homes selling in your area, but if you really want to obtain more details and information, reach out to a local real estate agent to run a comparative market analysis for you. An appraisal, another way to determine your home’s value, is a certified opinion of value which must be paid for and is normally requested when refinancing a mortgage or in the sale or transfer of property.
“Equity can be obtained in several ways,” Miller explains. “One is from the amount of the down payment at the time of purchase, assuming the loan amount is less than the appraisal value. Another is paying toward the principal each month, which can be accelerated by paying extra toward the principal balance on a regular or occasional basis. Third is that over a period of time, homes typically appreciate in value, so the difference between the loan amount and the value of the home continues to increase the equity position in the home.”
What Can You Do With Home Equity?
You have some home equity, but what can you do with it? For one, you can take out either a home equity line of credit or HELOC, a type of flexible credit line that works similar to a credit card, or a home equity loan, a type of second mortgage, to use that equity for something bigger. Generally, lenders won’t let you mortgage more than a total of 80% of your home’s equity, but you can use that borrowed money for so many different things.
“My advice for new homeowners looking to use their home equity is to make sure they have a good reason to borrow,” says Eric Hellon, broker at Caizen Realty in San Diego, California. “Some borrowers use the money to pay off credit card debt, only to find themselves back in debt again months later. If you are going to use your equity, use it in productive ways — add value to your home with equity-building upgrades, pay off one-time debts like college tuition or taxes and always be sure it is well within your budget to take on the new payments. There is interest being charged for the money you borrow, so it’s important to realize you will end up paying back more than you borrow.”
What Is ‘Negative Home Equity?’
Although the goal is to gain more equity over time, it doesn’t always work that way. Sometimes, when the economy isn’t doing so well, you may not gain more equity — you might lose some.
If the market value of your home drops below the amount of your mortgage, or your mortgage plus your home equity loan, you have negative home equity. For example, let’s say that the $350,000 home above was to drop in value to $280,000 because of a wider economic downturn. It still has a $300,000 mortgage, so now it has negative equity of $20,000, and you’ll have to pay off $20,000 in principal just to be at a break-even point. This is not a huge problem if you don’t plan to move any time soon, but can be difficult if you need to sell before your equity is positive again. Although the current risk of this is small, the housing market is facing some struggles and having negative home equity is a possibility.
“It is possible to have negative equity,” said Garrett Derderian, Director of Market Intelligence at SERHANT. in New York City. “While not entirely common today, it was prevalent during the Great Recession. During the Great Recession, home values sunk as the subprime mortgage crisis gripped the market, tanking home values. Today, most homeowners are in much better financial positions than the last downturn. With home values in most markets soaring over the last two years, very few people have negative equity. This could change if housing prices collapse.”
How Do You Increase Your Home’s Equity?
There are many ways to increase the value of your home, as mentioned above. Paying down your mortgage is the most direct route, but there are also lots of different projects that will return some percent of your cost to your home’s resale value.
Remodeling Magazine has been producing a “Cost Vs Value Report” for the last 20 years, tracking home upgrade costs versus their return. Top equity returning items according to their 2022 survey include replacing your garage door, adding stone veneer and performing a minor kitchen refresh. Of course, there are also timeless upgrades that always seem to help boost values.
“There are a few things that can make a huge difference in the value of a home,” says Matt Harmon, certified property appraiser at Harmon Property Solutions in Raleigh, North Carolina. “For example, finishing off space to increase the living area of the home, replacing the flooring or paint in a home, and doing a kitchen or bathroom remodel are some of the most influential.”
“However, there are some things that are just considered general maintenance that typically don’t have much of an impact. Those would be things like roof repair or replacement, some lighting or plumbing maintenance, and foundation work.”
The Importance of Home and Home Equity
Home equity is a way to increase your wealth and gives you an emergency pad to borrow against or a down payment for a future home, so it shouldn’t be tapped for just any reason. Each time you mortgage your equity, you’re creating a new loan that must be paid and that can cause your home to be foreclosed upon if you fail to do so, so never enter into a home equity loan lightly.
That being said, a home equity loan can also increase the value of your home dramatically if you plan carefully, are aware of all the fees you may need to pay to acquire and maintain your loan, and don’t overspend on the remodeling. The longer you’re happy to stay in your home, though, the more the value can increase over time, and the more equity you can grow.
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