There are multiple reasons why home ownership is considered a worthwhile investment. One of these is home equity
. While renting a property does not provide you with a return on your dollar, owning a home allows you an opportunity to build up equity as the property increases in value, and as you pay down your mortgage.
Below we outline what home equity is and how you can use it to your advantage:
The basic definition of home equity
is the current value of your property minus the amount you owe on any loans taken out against it. As you live in your home, two things are usually working in your favor to help increase your home equity:
• First, as you make mortgage payments each month, you reduce the total amount you owe on your home. Initially, most of your monthly mortgage payment will go toward covering interest and won’t make a large dent in your outstanding loan balance. As time goes on however, a higher percentage of each month’s payment will go toward reducing the principal you owe. It’s also possible to speed up the equity-building process by increasing your loan payments to pay more toward your principal each month. If considering this however, you should first discuss it with your mortgage lender to ensure you will not face a prepayment penalty for paying off your mortgage early.
• Secondly, the value of your home will typically appreciate over time due to a variety of factors, including economic factors, housing demand, and updates and renovations made to the property. While there have been many ups and downs in the housing market over the past couple of decades, the average American home increased in value 106% from 2000 to 2020.
Accessing Your Home Equity
Home equity is an asset, and you don’t necessarily have to sell your home in order to take advantage of it. In many cases, you can use your home equity to free up the funds you need to remodel your home, pay college tuition, start a business, pay off debt, or more.
Home Equity Loans - One way to utilize your home’s equity is to take out a home equity loan. With this type of loan, an appraisal is typically performed to determine the current market value of your home. Eligible borrowers can then borrow a percentage of the equity they have in the home, and receive the funds as a lump sum. Many home equity loans offer a fixed interest rate, where the borrower makes regular monthly payments towards the amount borrowed, plus interest.
Home Equity Lines of Credit - Another way to tap into your home’s equity is to secure a revolving line of credit using the equity you’ve built up in your home. This is called a Home Equity Line or Credit, or HELOC for short. It works similarly to a credit card. Basically, you are given a set credit limit that you can borrow from when needed, and you pay back the amount borrowed, plus interest over time. As you repay the borrowed amount, you can use the available credit again.
Cash-Out Refinancing - A third home equity option is to refinance your home with a “cash-out refinancing”. This allows you to restructure your existing mortgage and pull out some of your home equity as a lump sum.
Weighing Your Options
It’s important to weigh the pros and cons of home equity loans and lines of credit before making a decision to tap into your home’s equity. It is also important to look at your home equity as an asset, rather than just “found money”. Remember that your home equity is your money, and a HELOC or home equity loan just allows you to tap into that money early. If you are thinking of your home equity as extra money, you might be tempted to use it towards a risky investment or unplanned purchase, which could be financially harmful for you down the road.
Like any loan, defaulting on a home equity loan or line of credit can lead to serious consequences. With a HELOC or home equity loan, your home is used as collateral. That means, if you are not able to pay back what you borrow, you could risk losing your home. Therefore, it is very important to be sure you can repay whatever you borrow when you move forward with a home equity loan or line of credit.
To learn more about home equity options from BankFive, or to schedule a consultation to discuss which avenue might be best for your financial needs, contact us today.