Understanding Your Home Equity

Your home may be more than a place to live. Over time, it may also become one of your most valuable financial assets. Understanding your home equity can help you make more informed decisions about your mortgage and future.

By Sandy Biondo | Consolidated Lenders Group

If you've owned your home for a while, you've probably heard someone say:

“You have equity in your home.”

But what does that actually mean?

In simple terms, home equity is the difference between your home's current value and the amount you still owe on loans secured by the property.

For example, if a home is currently worth $600,000 and the homeowner owes $400,000 on the mortgage, the homeowner would have approximately $200,000 in equity.

That doesn't necessarily mean there's $200,000 available to withdraw, however. The amount a homeowner may be able to borrow depends on the type of financing, property value, existing debt, qualification requirements and other factors.

How Does Home Equity Grow?

There are generally two primary ways your equity can increase.

1. You pay down your mortgage. As you make mortgage payments, the portion applied to principal reduces the amount you owe. Over time, that can increase your ownership stake in the property.

2. Your home's value increases. If the market value of your property rises while the amount you owe stays the same or decreases, your equity may increase.

Home values can also decline, so equity isn't guaranteed to continually increase.

How Do You Know How Much Equity You Have?

A simple starting calculation is:

So, using our earlier example:

$600,000 home value − $400,000 mortgage balance = $200,000 estimated equity

Keep in mind that this is only an estimate.

If you're applying for financing, the lender may use an appraisal or another acceptable valuation method to determine the property's value.

And your total equity is not necessarily the same as the amount you can borrow.

Lenders generally require homeowners to maintain a certain amount of equity in the property, and qualification requirements vary by loan and borrower.

What Can Home Equity Be Used For?

Depending on your circumstances and available financing, you may be able to access a portion of your home's equity.

Homeowners consider doing this for many reasons, such as:

• Home improvements or repairs

• Major planned expenses

• Education expenses

• Consolidating certain debts

• Other financial needs

There are several ways homeowners may be able to access equity, including a home equity loan, home equity line of credit (HELOC), or cash-out refinance.

These options work differently, so it's important to understand what you're agreeing to before choosing one.

What Is a Home Equity Loan?

A home equity loan generally allows you to borrow a set amount using your home as collateral.

It is typically a separate loan in addition to your existing mortgage, with its own payment and repayment terms.

This can be useful when someone knows approximately how much they need and wants to receive the funds as a lump sum.

What Is a HELOC?

A home equity line of credit, commonly called a HELOC, works differently.

Rather than receiving one lump sum, a HELOC generally provides a revolving line of credit that allows you to borrow up to an approved limit during a specified period.

Many HELOCs have variable interest rates, meaning the rate—and potentially the payment—can change over time.

Because your home secures the debt, it's important to understand the terms, repayment requirements and potential payment changes before borrowing.

What About a Cash-Out Refinance?

A cash-out refinance replaces your existing mortgage with a new, larger mortgage.

The new loan pays off the existing mortgage, and the homeowner generally receives a portion of the difference in cash.

This can provide access to equity, but there's an important distinction:

You're replacing your entire existing mortgage—not simply borrowing the additional cash.

That means the interest rate, loan term, monthly payment and closing costs on the new mortgage all need to be considered.

If you already have a favorable mortgage, replacing it may or may not make sense.

Accessing Equity Isn't Free Money

This is probably the most important thing to understand.

Home equity belongs to you, but borrowing against it creates debt secured by your home.

Depending on the financing you choose, accessing equity may increase your mortgage balance, add another monthly payment, extend the time you're paying debt, or increase the total amount of interest you pay.

And because these loans are secured by your property, failing to make the required payments can put your home at risk.

That's why the question shouldn't simply be:

“How much equity can I take out?”

A better question may be:

“Does using my home equity make sense for what I'm trying to accomplish?”

Should You Use Your Home Equity?

There isn't one answer that's right for everyone.

Before accessing equity, consider:

Why you need the money • How much you need • Your current mortgage • The cost of the new financing • The monthly payment • How long you expect to remain in the home • Your overall financial goals

Sometimes leaving your equity untouched may be the better decision.

In other situations, thoughtfully accessing a portion of it may help accomplish an important financial goal.

The key is understanding the tradeoffs before making the decision.

Not Sure What Your Home Equity Could Mean for You?

If you've owned your home for several years and aren't sure how much equity you may have—or what your options are—Sandy can help you take a closer look.

She can discuss your existing mortgage, what you're hoping to accomplish, and available financing options so you can make a more informed decision.

You don't need to know which type of financing you want before reaching out. That's part of the conversation.

Every borrower's situation is different. Loan programs, rates, terms, property-value requirements, eligibility requirements and costs vary. Borrowing against home equity creates debt secured by your property and may increase your total borrowing costs. This information is for general educational purposes and is not a commitment to lend.