Almost everyone takes out a loan to buy a home. As the loan is being paid back, you build up the equity in your home. Home equity is the difference between the market value of your home and what you owe that bank on the loan.
For example, if your home has a market value of $500,000 and you currently owe the lender $300,00, then you have $200,000 worth of equity. Here is how home equity applies to your situation, and how a home equity loan may help.
How do you build equity in your home?
There are two ways that you build equity. The first involves the paying back of the mortgage. Every month when a payment is made to your lender, you reduce a portion of your principal.
Your principal is the amount of money you borrowed from the lender while the balance of your payment goes to paying the interest. At the beginning of your payment term (i.e., first few years), most of the payments you make on a monthly basis goes towards the interest payments.
Over time, your payments go towards your principal rather than the interest. The more you reduce the principal amount outstanding, the more equity you have in your home.
Some mortgages are structured in a way that allows you to make extra payments toward the principal each month. This reduces the amortization term of your mortgage (number of years you have to make mortgage payments) and helps you build equity faster.
The other way that equity accumulates within your home is the value increase of your home. If your home is worth more now compared to when it was purchased, your home gains equity. When your home appreciates in value as a result of market conditions and when you make improvements to your home, that extra bump in value further helps boost your home equity.
For example: Let’s say you find a home you want to purchase for $500,000, you pay a 10% down payment and are left with a $450,000 mortgage.
A mortgage is a loan you get to buy a house. A few years into your mortgage payments, as you pay off your mortgage each month, you’ve reduced the loan’s principal through your ongoing monthly mortgage payments.
At the same time, the home values in your neighbourhood have increased by 20%, and your home is now worth $600,000. When you factor in your loan’s reduced principal amount and the home’s increased value, you would have $100,000 in equity accumulated from the home appreciation as well as some $15,000 – $25,000 as a result of principal paydown (depending on your interest rate, amortization).
Can I access that home equity?
Yes. One of the primary benefits of home equity is that you don’t have to wait to sell your home to realize it. You can leverage that home equity by borrowing against it through either a home equity loan or a home equity line of credit (HELOC). Keep in mind that by borrowing against this equity in your home, you are using your home as collateral for the lender’s security.
You will have to make interest payments on this additional loan in addition to your regular monthly mortgage payments. It’s important to budget for both payments.
In conclusion, home equity loans are a great option if they are used responsibly and if you budget accordingly. You may decide to take out a second mortgage to make significant improvements to your home, and in doing so, the value of your home may increase and perhaps even negate the loan that was taken out for home improvements.
If you are looking to refinance or purchase a home over the next few months, contact us today at 877-296-2696 or email us at email@example.com.