What Is a Home Equity Investment?
You’ve heard that real estate is a good long-term investment. But when you consider the prospect of taking out a personal loan for hundreds of thousands of dollars, it can be difficult to understand why.
It all comes down to your home equity investment—the portion of your home that you own outright. Want to understand how you develop home equity and how you can enjoy it over time?
In this guide, we’ll give you the 411 on home equity and the ways you can tap into it.
Home Equity Explained
When you buy a $200,000 home, it doesn’t necessarily mean you have a $200,000 asset.
Because most people finance their homes. In fact, 64% of buyers use mortgage loans to pay for their homes. That means buyers put down a percentage of the sale price in cash (also known as a “down-payment”), and the rest of that sticker price is paid by the bank.
- Through loan programs with the Federal Housing Authority, Veterans Administration, and Rural Housing Authority, first-time homebuyers can put down between 0% and 3.5% on a primary residence.
- Other buyers typically need a 20% down payment to secure mortgage financing for conventional 30-year mortgage loans.
In your first year as a homeowner, that means you probably share your ownership with the bank. In fact, depending on your down payment, your equity—the portion of the home you actually own—could be as low as 0%.
- If you put down 0%, you might not have any equity at all until you begin making mortgage payments.
- If you put down 3.5% on a $100,000 home, you would have at least $3,500 in equity.
- If you put down 20%, you would usually have $20,000 in equity.
How Appraisal Affects Equity
Above, you may notice that we said you’ll usually have a certain amount of equity when you first purchase your home. But, depending on your home’s appraised value, you might have more (and, in some rare cases, less).
Why? It all comes down to the appraised investment property value versus your loan amount.
Say you offered $200,000 on a home and plan to put down 20%. That means you need a loan for $160,000. Would you necessarily have $40,000 equity in the house?
- A bank will agree to finance your mortgage based on the offer you make on the house. Before approving your personal loan, the bank requests an appraisal to make sure the home is actually worth what you offered.
- If the house appraises over value, you might automatically have more equity. Say the bank finds it’s actually worth $210,000 and offers you a loan for that $160,000 you need. In that case, you actually own slightly more of the home’s total appraised value—$50,000.
- If the house appraises undervalue, the bank may not approve your loan. Maybe it appraises at $190,000, and they’ll only give you a loan for $152,000. If you have $48,000 in the bank, you could still choose to purchase the home with that financing. But since the home is worth $190k and you owe $152k, you’ll only have $38k in equity.
Gaining Equity Over Time
In reality, you’ll likely start off with a certain amount of equity in your home. But you still owe tens of thousands on your loan! Luckily, your home’s value will probably appreciate over time due to the following factors:
- Mortgage payments – As you make your monthly mortgage payments, you’ll begin to own more of your home. At first, each mortgage payment will probably go towards loan interest and other costs. But over time, you’ll own your home outright. To that end, the typical home loan term is 30 years. To maintain ownership and avoid foreclosure, make each mortgage payment in full and on-time monthly.
- Renovations and improvement – When you purchase your home, it might need some repairs and upgrades. As you replace old flooring, repaint walls, and update the plumbing, you increase the value. Keeping your house in tip-top shape is key, but the sky’s the limit with improvements. Amazing landscaping, up-to-date appliances, and gut renovations can all increase the lump sum value of your home or investment property.
- Time – You’ve probably heard a friend say that they wish they bought a house in Brooklyn, San Francisco, or some other desirable locale “back when it was still affordable.” It’s intuitive that real estate tends to become more expensive as demand grows. That means you can gain equity just by waiting for time to pass.
Will My Home’s Value Go Up?
Are you wondering whether a particular property is a good home equity investment?
During the Covid-19 pandemic, real estate hit record highs in many areas of the country due to high demand and low supply. Low-interest rates made it affordable to take out loans, so people were looking for primary residences and investment properties nationwide.
But if you’re concerned your home or investment property value might not go up, talk to a licensed real estate agent before making your investment decision. After all, appreciation is a huge benefactor when it comes to owning real estate. You need to ensure it’ll work in your favor.
Accessing Your Home Equity
So you’ve made timely mortgage payments and stylish renovations. You’ve waited and waited, and now your home equity value has gone up.
Is there a way you can actually get access? Wondering how to use home equity to your advantage?
More importantly, should you?
The short answer is yes. It’s your investment to use however you want!
There are several possible ways to start enjoying the hard work and financial investment you’ve put into your home.
Here are some alternative ways to get equity out of your home:
Selling Your House
One option for seeing a return on your investment is selling your home and moving. Whether you’re ready to upgrade to a bigger home or move to a different area, your equity can finance your dream.
Just be prepared for all aspects of the selling process:
- Listing and showing – Selling your home is often a stressful and time-consuming process. To land the maximum price, you’ll need to complete all the home improvement projects on your to-do list, hire a photographer and home stager, and then prepare for dozens of potential buyers to traipse through your property. Hopefully, they’ll like what they see!
- Closing Costs – If you’ve bought a home, you already know that real estate transactions come with certain costs, from sale taxes to attorney fees. As the seller, you’ll typically also pay your realtor and the buyer’s realtor a fixed percentage of the sale price as a commission.
- Coordinating your move and purchase – The only thing more complicated than selling a house? Attempting to buy and sell simultaneously. After all, you may need the cash from the sale of your home in order to close on your next one. If one real estate transaction doesn’t go according to plan, it can upend the other, leaving you scrambling for a place to live or for cash to finance your next home.
Refinancing Your Mortgage
Don’t want to move? There are other ways to access your equity.
Refinancing is a way to change the financial terms of your mortgage agreement to secure a lower interest rate and monthly payment. In the process, you can also take cash out.
- Your refinancing bank will request a new appraisal of your house to determine the amount of equity you have based on the remaining home loan balance.
- At that point, you can take equity out in the form of cash. However, keep in mind that this isn’t a gift. Instead, the amount you take out is actually added back to your loan balance. Say you have $100,000 equity in a home appraised at $200,000. If you take out $50,000 in cash, your new loan balance will be $150,000.
When you refinance, you’ll also pay a variety of bank fees and closing costs, which can dip into your profit. That means you can’t take out 100% of your home’s equity. Before you go with this option, make sure to fully weigh the benefits of refinancing and the disadvantages of refinancing.
Home Equity Loan
Another option is taking out a loan against your home’s equity.
Say you have $100,000 in equity. You could take out a $20,000 loan to make improvements on your home, pay down high-interest credit card debt, or meet another financial goal. Just keep in mind that you’ll have to pay the loan back. In addition, home equity loans can come at a higher interest rate than a mortgage refinance. Just be sure to consider both the pros and cons of home equity loans before you go with this option.
Many people are attracted to refinancing and home equity loans because they want to stay in their homes and enjoy the financial benefits of their hard work.
Unfortunately, home equity loans and mortgage refinancing ultimately add to your debt. While you can enjoy the cash now, you’ll have to pay back the loan in the future (or hope that your investment in home improvements or other ventures quickly gives you more home equity).
But another option is the sale-leaseback.
This can be an effective route if you want cash in hand while you search for your next home. When you sell your home, you can try to negotiate this option with the buyer. It all depends on finding a trustworthy partner.
Convert Your Home Equity
There are countless unique reasons why a homeowner wants to access their equity, such as paying off debt, funding a business, or paying for their children’s college education.
A sale-leaseback solution makes it possible to convert your equity to cash and eliminate your mortgage payments.
To understand a home equity investment, why it’s important, and how you can access it, talk to a financial advisor. There are several options available to you to help you make the most of your home equity.