Home equity is the difference between the value of a home and how much debt is owed on the home. For most homeowners who have a standard mortgage, it is the difference between the assessed value of the home and the amount remaining on the mortgage. Home equity is a valuable asset for homeowners, as it can be used for various purposes, such as paying for home improvements, consolidating debt, or financing a child's education.
The value of a home is determined by the market, and it can fluctuate over time. The amount owed on the home, however, remains the same unless the homeowner takes action to pay off the mortgage or refinance the loan. As the value of the home increases, so does the amount of equity the homeowner has in the property. Conversely, if the value of the home decreases, the homeowner's equity decreases proportionally.
Let's look at a few examples:
1. Equity Value When a Home is First Purchased:
Let's consider a scenario where you are looking to buy a home. After reviewing several options within your budget, you find a home that you would like to purchase and make an offer of $300,000. The seller agrees, and you proceed to take out a mortgage to finance the purchase.
Banks generally require a 20% down payment when taking out a mortgage, so in this scenario, the required down payment would be $60,000, and the mortgage balance would be $240,000 (to be paid over 30 years). The $60,000 down payment immediately becomes equity in your home, representing the difference between the home's value ($300,000) and the amount owed on the home ($240,000 mortgage balance).
This equity is your money, and you can use it in various ways, such as tapping into it for home improvements or investing in other assets. If you were to sell the home for the same price you paid for it, the $60,000 in equity would turn into cash that would go into your pocket.
2. Equity Value When the Mortgage Balance is Paid Down:
As you make monthly mortgage payments, you gradually build up more equity in your home. Each payment you make decreases the amount owed on the mortgage, which, in turn, increases the equity value in the home.
For instance, if over several years, you were able to pay down your mortgage balance from $240,000 to $200,000, your equity value in the home would increase by $40,000. Your new equity value would now be $100,000, as you started with $60,000 in equity from the down payment and decreased your mortgage balance by $40,000, which also became equity.
The value of the home remains $300,000, and the amount owed on the mortgage is $200,000, so the difference of $100,000 represents the homeowner's equity.
3. How a Change in Home Price Impacts Equity:
So far, we've been assuming that the value of the home remained the same during the time the homeowner was paying down the mortgage balance. But what happens if the value of the home changes?
Let's assume that instead of remaining flat, the value of the home increased by 20% over the period, rising from $300,000 to $360,000. The $60,000 increase in home value would now also become equity for the homeowner. In this scenario, the homeowner still owes $200,000 on the mortgage and the home is now worth $360,
Home equity is an important aspect of homeownership and real estate finance, and it is crucial for homeowners to understand what home equity is and how it can be used. From home equity loans and lines of credit to cash-out refinancing and HECMs, there are several options for homeowners looking to tap into their home equity. However, each option has its own advantages and disadvantages, and homeowners should carefully consider their options before making a decision.
In conclusion, it's essential to understand home equity and how it changes over time. It is an essential aspect of real estate finance and can provide homeowners with a source of funds for various expenses, investments, or emergencies. By being knowledgeable about home equity and the various options for accessing it, homeowners can make informed decisions