For many Americans, a home is the most valuable asset in their possession. But not every home is owned outright. Less than 40% of Americans are free and clear of their mortgage.
The fact is, most people need the help of a mortgage loan to acquire their property. And, in that case, their home equity is the actual stake in the home that they do own.
But what does it mean to have equity in a home? How do you calculate it? What are the benefits of having equity? What does home equity mean?
Here’s what you need to know.
What Does Home Equity Mean?
The most simple home equity definition is the current market value of the home minus the mortgage balance. Put simply, the home’s price minus the bank’s ownership stake and interest is what you truly own.
So, for instance, if your property value is $1,000,000 and you owe $450,000 in mortgage payments, the difference of $550,000 is your home equity. By dividing that equity from the property value value, you can calculate a 55% equity stake.
In this case, the mortgage lender doesn’t own the property. Rather, the property is used as collateral. The mortgage lender puts a lien against it to make sure that you pay your bill, which is the installment debt. After you have paid off both the initial home value and the interest of the loan, the home is all yours.
How Does Home Equity Work?
Using our previous example, let’s pretend your home value doubled from $1,000,000 to $2,000,000 thanks to market increases and home improvements that increased the property’s worth. As a result, your home equity is $1,550,000. By dividing that equity by the home’s value, you now have an equity stake of 78%.
But home equity isn’t always fated to increase.
In many cases, there are external factors that dictate whether home prices increase or decrease. For instance, if you live in a town with a declining population, there may be less demand for homes. As a result, lack of demand can drive down the average price of a home. Were that to occur, your home equity may then decrease.
How to Build Home Equity
Equity is not static. It can increase or decrease depending on the circumstances.
There are three primary ways you can increase your home’s equity:
Pay Down Your Loan’s Principal Balance
At the beginning of your journey as a homeowner, you may have only a small percentage to your name. But, as you make your monthly mortgage payment, part of that installment goes toward paying your interest for the loan, and the other part goes toward paying off the loan’s principal. This type of debt, known as “installment debt,” involves regular payments made over time, which typically include both principal and interest. And when the loan balance goes down, your equity stake goes up.
Wait For Your Home’s Market Value to Increase
A home’s market value is subject to fluctuations. For instance, due to Covid-19, there was a surge of market demand that drove up the price of houses across the country. There has been a staggering 24% annual increase in the median estimated home price since the Pandemic began.
Make Home Improvements
Instead of waiting for your home’s value to increase, which is not guaranteed, you can help your cause by renovating certain rooms or adding new amenities to your house. Upgrading your bathroom and kitchen are great ways to boost the value of your home. Additionally, updating your home’s energy efficiency can also increase its value, lower utility costs, and possibly qualify you for a tax credit.
You don’t always have to make major changes to improve your home’s value. Simple tasks like painting a room or enhancing your home’s curb appeal can help make a significant difference.
Why Is it Good to Have Equity in Your Home?
Owning your home, even if it’s not owned in full, helps protect you from risk. Should something bad occur, that’s a valuable asset you can leverage should the need arise.
This is why building equity is often considered to be preferable to renting. Instead of simply paying money each month to live in a place that someone else owns, you pay to slowly acquire your property.
It may take time to build up your equity, but having patience and persistence is worth it.
Home Equity Is a Valuable Asset
You may not always want to live in your home. Eventually, you may decide to sell it. That could be to downsize, move to a new location, upgrade, or simply take advantage of a seller’s market. If you do decide to sell the home, the more equity you own, the more profits you can take, especially if your home has increased in value.
Over time, building equity increases your net worth. And, historically speaking, it’s one of the better investments American’s can make. According to the Federal Reserve’s 2020 Survey of Consumer Finances:
Homeowners have a net worth that is more than 40 times greater than their renter counterparts, which reinforces the idea that owning a home is a smart financial move. The average homeowner had a median net worth of $255,000 in 2019 while the average renter had a median net worth of just $6,300.
And, as the survey notes, it’s not just the home’s value that’s beneficial. It’s also the mindset of being financially responsible enough to save up for a down payment, qualify for a mortgage, and then budget efficiently to pay off your mortgage debt.
How to Access Your Home Equity
Life is full of uncertainties. You never know what the future holds. But having home equity is a valuable hedge against life’s risks.
Home equity is an asset that you can tap into when you need it. Wondering how to use home equity ? It could be used for a medical emergency, pay for upgrades in your home, to fund a business venture, consolidate your debts, or pay off college loans.
And today, there are a variety of ways you can convert your equity into cash including:
A Home Equity Loan
A second mortgage loan leverages the equity accrued in the home as collateral. Typically you need to have at least a 15%–20% equity stake to borrow up to 85% of the home’s value. In exchange for the loan, you receive a one-time lump sum that needs to be repaid at a fixed interest rate. However, there are pros and cons of home equity loans that are important to consider before you go this route.
A Home Equity Line of Credit
Another way to get equity out of your home without refinancing is with a HELOC. If you have at least 15% home equity and a decent credit score, a home equity line of credit (HELOC) lets you borrow cash against your home’s value and equity. Unlike a home equity loan, a HELOC works more like a revolving line of credit. The loan funds are drawn as needed.
A Cash-Out Refinance
A cash out refinance is a type of mortgage refinance that typically goes for more than the amount owed. In this case, the borrower withdraws that difference in cash. This replaces your current home loan with a larger one, allowing you to withdraw a portion of your home’s equity in one lump sum. A cash out refinance is a common route taken by homeowners that want to remodel, especially since the upgrades will very likely increase the home’s value, and thus increase their equity stake.
A Residential Sale-Leaseback
With a residential sale-leaseback, you essentially sell your home to a buyer who then leases it back to you for you to remain living in. You no longer own the home, but still are able to stay and live in it as a renter. In doing so, you convert your home equity into cash for you to pay off debts or reach your financial goals, all while keeping the option to repurchase your home in the future. There are many residential sale-leaseback benefits, so explore this option and see if it’s right for you.
Be sure to check out various other alternative ways on how to get equity out of your home.
Benefits of Using Your Home Equity
Depending on your circumstances, using your home equity can be a savvy financial decision for the following reasons:
Current tax laws allow homeowners to deduct the interest on home equity loans or HELOCs if the money is used to then fund home improvements so long as they are used to: “Buy, build or substantially improve the taxpayer’s home that secures the loan.” That said, there are limits to how much interest can be deducted.
Low Interest Rates
Compared to a credit card or some other unsecured loan, a secured loan that’s backed by your home will typically have a much lower interest rate. And, in the case of a HELOC, you only pay interest on the money borrowed.
Flexible Term Periods
The loan term for most home equity loans typically ranges from approximately 20 to 30 years, offering flexibility in repayment. So long as you make your payments on schedule, you’ll eventually pay off the full loan amount.
How to Use Your Home Equity
When it comes to how to use home equity, there are a variety of things that you can do with it. Some common ways people use their home equity include:
Home Improvement & Repairs
Home equity can be used to finance home improvements and repairs. If you have a large enough real estate portfolio, you can use the equity from one or more of your properties to pay for renovations, repairs, or remodeling projects on your current residence.
Consolidating Credit Card Debt
If you’re looking to reduce your monthly payment obligations and get out of debt, using your home equity to consolidate credit card debt may be a good option. As mentioned above, home equity loans and HELOCs typically offer lower interest rates than credit cards, so you’ll save money in the long run.
Starting a Small Business
Finally, you can use your home equity to start or expand a small business. A home equity loan can provide you with the capital you need to purchase equipment, cover start-up costs, or hire additional staff. You can even use the funds to invest in yourself by taking classes, networking, or other professional development activities.
A Sale-Leaseback Program: Your Way of Accessing Home Equity
So what does equity in a house mean? Essentially, equity in a home is one of the most important ways Americans can accrue wealth. By investing in a home, you gain access to an asset that accrues value over time. And that value can then be leveraged if need be.
But traditional means of tapping into a home’s equity are outmoded. The barrier to entry is often quite high. There may be income or credit requirements that prevent you from acquiring the loan. Not to mention, it’s rarely a good idea to stack debt atop an existing mortgage balance.
That’s where a sale-leaseback program may provide a better alternative that makes your home equity work for you.
Are you looking to gain equity from your home? We will offer a solution to obtain this equity found in your house. If you are still unsure of alternative options to securing this equity after reading this article, consult a financial advisor to discuss your options.
- Forbes. Nearly 40% of homes in the U.S. are Free and Clear of a Mortgage. https://www.forbes.com/sites/brendarichardson/2019/07/26/nearly-40-of-homes-in-the-us-are-free-and-clear-of-a-mortgage/?sh=2f4f83f247c2
- Fortune. Home prices are rising faster than ever before. https://fortune.com/2021/07/21/home-prices-rising-us-record-rate-2021-update/
- The Balance. How to Build Equity and Own More of Your Home. https://www.thebalance.com/build-equity-315654
- Forbes. Is Buying A Home Worth It? To Find Out, We Asked Nearly Two Dozen Experts. https://www.forbes.com/advisor/mortgages/is-buying-a-home-worth-it/