What is equity and how is it used? (2023)

If you're interested in home ownership, "equity" is probably one of the home buying terms you come across often, but you're not entirely sure what it means.

If you think of your home as a pie, your piece of the pie will gradually get bigger while your lender's piece of the pie will get smaller. Equity is the value of your slice of the pie.

How does equity work?

Equity may be expressed as a percentage or as a monetary value.

Going back to the bag of cash example, whoever buys his house owns the entire house, so he owns 100% of the equity. If that house has a market value of $400,000, you might as well say they have $400,000 in equity. Both numbers refer to the same piece of dough.

How to calculate equity

Of course, most people don't buy a house right away.

Let's say you buy a house that's also worth $400,000, paying 10% less and taking out a mortgage on the remaining $360,000. Immediately after you buy a home, you own 10% (or $40,000) of equity in the home, and that number increases as you pay off your mortgage.

At any time, you can always calculate the monetary value of your property by subtracting the estimated current market value of your home from the amount you still owe on your mortgage:

The market value of your home - the amount you still owe for the home = your equity.

The formula above will give you the current cash value of equity. If you want to know your equity as a percentage, simply divide that cash value by the current market value of your home.

Let's look at an example. After several years of regular mortgage payments, you now owe your lender less money: Before interest, you paid $80,000 in addition to your $40,000 down payment. You have now paid off a total of $120,000 and still owe $280,000.

IfYour home's market value remains at $400,000, which means:

Market value $400,000 - $280,000 still owed =$120,000 in equity

If you want your equity as a percentage, divide this cash equity value by the current market value of your home:

$120,000 equity ÷ $400,000 market value =30% of equity.

So if someone were to cut this homemade cake today, your slice would be 30% of the cake and would be worth $120,000 in the cake market. Your lender's share, currently 70% of the pie, is valued at $280,000. (It's an expensive cake.)

Can I change my housing fund?

Equity can change and of course it does.

As we just saw, you can increase your home equity simply by making monthly mortgage payments as you own more and more of your home. However, if the market value of your home changes, so does your equity (for better or worse).

Let's look at two examples.

I. Increase your home equity

We're going back to our $400,000 house. For the past few years, you've been paying off $80,000 in principal each month plus a $40,000 down payment, so you've made a down payment of $120,000. You still owe $280,000.

You can roughly estimate the value of your home by looking at current prices for similar homes in your area and discovering that - due to market conditions and other factors - your home's value may go up (although if you really want your equity, you'll need to get a professional appraisal ). You estimate that your home is currently worth about $440,000.

If you do the same calculations we did above, you'll get an estimated net worth:

Market value $440,000 - $280,000 still owed =$160,000 in equity.

Equity $160,000 ÷ Market capitalization $440,000e = 36% of equity.

Because your home has become more valuable, your equity is now worth $160,000 instead of $120,000. You basically made $40,000 doing nothing. You also own a higher percentage of equity - 36 percent - instead of the 30 percent you would have if the price of the house had not changed.

The key is to remember that your home's market value may change, but your original mortgage amount won't: if you take out a $360,000 mortgage, even if your home is ultimately worth $4 million instead of $400,000.

This makes owning a home a very smart and easy way to build wealth. As for what you can do with this added value, we'll go into more detail below. But first...

two.decrease in equity

Unfortunately, the same can happen in reverse.

We'll use the same example where you buy a $400,000 home, make a $120,000 down payment, and owe a $280,000 mortgage. But this time the value of the house has gone down and it is now worth $360,000.

If we do the same calculations we find:

Market value $360,000 - $280,000 still owed =$80,000 share capital

Equity $80,000 ÷ Market capitalization $360,000= 22% of equity.

Even though you paid $120,000 for your own home, your equity in that home is currently $40,000 less than what you paid for it. Your home equity percentage has also decreased: you own 22% of the home instead of the 30% you would own if the home price stayed the same.

Of course, any staking calculation is essentially a snapshot in time. If the value of your home drops temporarily, it can rise again at any time. This is one reason why it's important to be as flexible as possible in your schedule if you plan to sell your home or use your property to make it as valuable as possible.

What is equity used for?

We'll tackle the weeds of home equity loans below, but for now, let's just say that your equity can help you get low-interest loans - the more equity you have, the more money you can borrow.

There are different ways to use equity.

Opting Out of Private Mortgage Insurance (PMI)

If you take out a conventional loan and make a down payment of less than 20%, your lender may promisePrivate mortgage insurance(PMI) pays the monthly mortgage payment. A PMI of 0.3% to 1.5% of the loan value may not seem like much, but it adds up: A homeowner with a $360,000 mortgage canexpect paymentPMI is around $100-250 per month or $1200-3000 per year.

The good news is that once your equity reaches 20%, you no longer have to pay PMI. Once you reach 22% equity under the regular payment plan, the lender will automatically waive the PMI requirement, but you can request a waiver once you reach 20%.

If you think you've hit your target 20% early - say, if home sales in your area are on the rise and you think your home is worth more than it is - you can tell your lender. They will want a professional appraisal of the home and if it is determined that you have indeed reached 20% equity, you will no longer have to pay PMI.

DIY at home

Another common use of home equity is home improvement. Not only do home equity loans typically offer lower interest rates than credit card loans or personal loans (more on that below) - the interest on these loans is often tax deductible if you use the funds to increase the value of your home. in turn, it allows your home to be worth more by increasing capital - a very economical move.

tuition

Tuition and college expenses are another common use of equity as interest rates are often lower than for student or personal loans. It's also a great way to consolidate your student loan debt into one payment.

High interest debt consolidation

The same goes for almost any type of debt. With extremely low interest rates, a home equity loan is a smart way to consolidate debt such as credit cards, car payments, and personal loans into monthly payments. When you take out a low-interest home equity loan to pay off all your other debts, you pay one mortgage per month instead of several separate mortgages. Not only is it a convenient way to organize your finances, but it can also save you a fortune with lower interest rates.

How to borrow equity

If you want to build equity in your home, you should have it professionally valued. As we mentioned earlier, you can get a rough idea of ​​the current market value of a home by looking at the selling prices of similarly sized homes near you, but if you want to make money, it shouldn't be based solely on appraisals. This is one of the reasons why a home equity loan lasts longer than other loan options.

As we mentioned, another key factor in home equity loans is the relatively low interest rates. You may find yourself paying 4%-6% interest on a home equity loan, compared to 15% on a personal loan and closer to 20% on a credit card.

That said, it's important to remember the reason for these low interest rates: Unlike unsecured debt like a credit card or personal loan payment, borrowing against your home's value means you're putting your home up as collateral. This means that the lender may lose your home if you are unable to make payments. This is one of the reasons why home equity lending is as carefully considered as any other type of loan.

one.home equity loan

A home equity loan, also known as a second mortgage, is similar to any other type of loan in many ways: you apply for a fixed amount that you agree to pay back on a pre-determined schedule with a fixed interest rate and repayment amount. Once you agree to a loan, you get all the money in one go.

The amount of equity in your home directly affects the amount you can borrow. First, lenders typically require 15-20% equity to qualify for a home equity loan of any amount. Then, in determining your consolidated loan-to-value ratio (CLTV), the amount of assets you have determines how much you're eligible to borrow - which basically means the maximum amount a lender can lend you.

In general, lenders can provide you with up to 80%-90% of your current equity, so if you have higher equity, you may qualify for a larger loan. But it's important to note that this amount is an upper limit: lenders may offer less than this amount, depending on factors such as income and credit score. They will also affect the types of prices offered.

West.Heroco

Almost everything we said about home equity loans also appliesHome equity line of credit (HELOC)The main difference is in the method of withdrawing funds. While a home equity loan gives you a lump sum, HELOC works more like a credit card, you can theoretically borrow the maximum amount, but you can only get what you need at any given time, and your monthly bill depends on how much you withdraw.

However, unlike credit cards, which require you to pay off the balance almost instantly, HELOCs have a "drawing period" of up to 10 years, during which time you only pay interest on the money you borrow. More capital must be repaid. This can save you a lot of money in the short term, but keep in mind that higher payments await you - and the more you take out (and the less you pay back), the higher they will be.

HELOC rates are often variable and can change so frequently from month to month that your payment amount will fluctuate depending on the market. This carries the same risks as a variable rate mortgage - your interest rate can go down or up - so this option is best for those who can afford some risk.

Do.HELOC fixed rate

While most HELOCs have automatic variable rates, some lenders offer fixed rate options. That's exactly what it sounds like: HELOC with a fixed rate gives you a fixed monthly payment instead of a rate that can change over and over again. If you want to avoid uncertainty, HELOC with a fixed rate may be right for you. Their repayment periods are usually longer than those with variable rates. Deciding which type of HELOC you want is essentially the same decision you would make with a fixed or adjustable rate mortgage.

Hello.reverse mortgage

A reverse mortgage is typically available to homeowners 62 and older who have paid off their mortgage and want to continue living in their home as their primary residence. In this model, they receive recurring paymentszTheir honesty, not the other way around.

Suppose a 65-year-old homeowner has paid off his mortgage and therefore owns 100% of a $500,000 home (or, in other words, owns $500,000 in equity). A reverse mortgage allows homeowners to convert their equity into regular cash payments, almost like a paycheck, although it's important to remember that this is borrowed money that needs to be repaid. If you wanted $500,000 deposited directly into your bank account, you would have to sell your house, hope for a good price, and find a new place to live.

There are no reverse mortgage fees, but you still have to pay home insurance and property taxes. A reverse mortgage also doesn't require payments until the homeowner moves, sells, or dies (in which case co-borrowers or heirs of the homeowner will have to repay the amount borrowed to the homeowner).

Rice.pay refinancing

A payday refinance falls somewhere between a home equity loan and a reverse mortgage. If you still want to live in your home while increasing your equity - and if you want to start paying it down right away - a payday refinance may be for you.

Let's go back to our old friend, the $400,000 house. Now it's been a while and you've paid $120,000 for the house plus a $40,000 down payment. You now owe $140,000 on your original mortgage. The value of your home also increases from $400,000 to $480,000.

Even if you now owe "only" $140,000, you can now take out a new mortgage for the full value of your home - so you can take out a new mortgage for $480,000, leaving $140,000 to pay off the first one. Take a mortgage and keep the remaining $340,000 and do whatever you want. It can be a great way to meet other financial goals, such as paying off a student loan, home improvements, or paying off high-interest debt, but how you spend it is up to you. What's more, the money you withdraw is also tax-free.

6. 5 tips for building equality in the family

All of this sounds great – but how do you create equity in your home? There are many ways to increase your equity, but here are some of the most popular.

1. Larger down payment

This may seem a little obvious - but when buying a home, make as much of a down payment as possible. The larger the down payment, the more percentage of the house you will own upon closing, allowing you to use the upper floor.

2. Consistent mortgage payments

Here's another easy way - pay off your mortgage on time as much as you can afford (preferably above the minimum required payment). The more you pay each month, the longer your home will last and the faster it will be paid off.

3. Refinance into a short-term loan:

Similarly, if you can afford it, consider speeding up the mortgage repayment process by refinancing for a shorter loan term. Not only will you pay off your loan faster, you'll likely get a better interest rate and save money by avoiding interest on larger loans.

4. Consider home improvements that can increase its value

Examples include remodeling your kitchen or bathroom, replacing siding, improving your home's energy efficiency, or replacing your garage door. Keep in mind that home improvements don't automatically add value to your home, so you'll need to check which ones will pay for it (of course, any renovations pay off for you personally - it's your home after all!).

5. The last one is probably the easiest:

stay put. While you can sell your home at any time, the longer you stay in the home, the more likely it is that its market value will increase as well as your equity.

building capital is a good thing

With any luck, the idea of ​​equity makes more sense at this point. It may also be clearer why renting is somehow tantamount to running out of money - because no matter how many times you pay, you'll owe the same amount each month (if you're lucky) and you're not even close to owning a rented house or your apartment.

Paying off your mortgage, on the other hand, is more like putting your money in a safe that you can open with your equity.

At K. Hovnanian Homes, with meticulous attention to detail and exceptional customer service, we pride ourselves on building beautiful new homes and communities in all countries - with a wide range of homes and plans available, you're sure to find a new home to suit your needs, lifestyle and budget.

Want to know more?contact us todayor use our search engine on the home pageFind the K. Hovnanian communitynear to you!

Last updated: April 18, 2023