What Is Home Equity? A Guide for Homeowners
If you're a homeowner, you may have heard that home equity opens many doors and opportunities when it's time to sell, time to upgrade, or when you need emergency cash. Knowing what home equity is, how it can help you achieve your financial goals, and what you can do to build up home equity is important. Here's what you need to know.
What Is Home Equity?
Home equity is the difference between the value of the home and the value of loans, liens and other encumbrances against the house. Home equity is, in theory, how much the homeowner would walk away with in cash if they were to sell their home tomorrow.
When a home buyer puts 20% down to buy a house, they theoretically then have 20% home equity. As the years pass, they should build up more home equity, as long as the value of the house stays the same or rises.
If the value of the home falls, then the homeowner may lose equity. If the value of the home drops steeply, the homeowner may even go underwater on their mortgage, meaning they owe more than the value of the house. In this case, the homeowner would have to pay money to pay off their mortgage if they sold their house.
Why Is Home Equity Important?
Homeowners can use equity in their home to borrow money against the house or refinance their existing loan. These loans can be used to make home improvements or even pay for emergency expenses, although homeowners should be very careful when borrowing money against their house. Many experts agree that the smart way to borrow money against a house is to use the money to invest in the house itself, thus boosting the value of the home and more quickly returning to a state of more equity in the home.
How Can You Build Up Home Equity?
Homeowners build up equity in their home by paying off their mortgage. When they make on-time payments, the amount of money they owe goes down, and the amount they would make in profit if they sold their home goes up.
Thinking About Using Home Equity to Borrow Money?
Homeowners who have built up home equity and who need to borrow money against their home equity should follow these tips.
Know Your Options
There are many types of home loans and borrowing options for homeowners who have equity in their house. Home equity loans, home equity lines of credit (HELOC) and cash-out refinance loans are just a few of the options that homeowners have access to. Before choosing a type of loan, the homeowner should first know the options available, read the terms of the type of loan they're thinking about getting and possibly consult with a financial advisor before signing on the dotted line.
Different lenders will offer different interest rates and loan packages. Some loan options are better than others. Homeowners can get the best deal by shopping around with different lenders.
The more they shop, the more aware of their options they'll be. It's important to be careful when talking to lenders, as some may ask to check the homeowner's credit to determine whether they're qualified. Doing this too many times over a long period can reduce the homeowner's credit rating, which in turn can make it harder to borrow when the time comes.
Borrow for the Right Reasons
Any loan that would reduce the homeowner's equity in their house poses a risk to the homeowner. It's important, therefore, to borrow for the right reasons. For example, it's often said that a loan obtained by using the homeowner's equity should not be used to purchase a car. Home loans often take a long time to pay off.
A homeowner who uses a home equity loan to buy a car could be paying off the loan long after they no longer drive or own that vehicle. Homeowners who aren't sure whether the loan is appropriate for the item they're buying or the bill they're planning to pay can check with a financial planner for guidance.
Selling Your Home? Work with a Real Estate Professional
If you're a homeowner who would like to sell your home and you're hoping to take advantage of your home equity, consult with a real estate professional. Your real estate agent can help you get the most money when your home sells. This is important because the more money you make when your home sells, the more you'll have to invest in your next home, which will help you build equity in your next home more quickly.