See how home equity works and what affects its value.
Building home equity is one of the most common ways to build financial security and wealth. To make it work for you, you need to understand how it works. Here’s a quick overview.
How to calculate home equity
Calculating home equity is simple math:
Home’s Market Value – Home Loans = Home Equity Value
So, if your home is worth $450,000 and you have a balance of $200,000 on your mortgage, you have $250,000 in home equity.
A home’s market value is what a buyer would pay. You can estimate your home’s value by looking at what comparable homes in your location have recently sold for. Keep in mind that a home’s size, condition and features influence the value. You can also hire a property appraiser for an objective assessment of your home’s market value.
If home values go up, so does home equity. For example, if a buyer makes an all-cash purchase of a home for $300,000 and it could now be sold for $375,000, a rising market results in the buyer having $375,000 in equity. On the flip side, decreasing home values also affect home equity. Let’s look at the same $300,000 home purchased with cash, but the market value drops by $25,000; the owner now only has $275,000 in home equity.
Home loans in the formula above include mortgages, home equity loans and home equity lines of credit.
How improvements increase home equity—or not
Some folks make the mistake of thinking every dollar they invest in repairs and upgrades automatically increases their home’s value and therefore their equity. In some cases it does but in many cases the money put into improvements is simply upkeep. (Check out the resale value of popular remodeling projects from The Journal of Light Construction.)
When doing home projects keep in mind that quality of work can increase or decrease a home’s value. A well-constructed and finished addition that increases living space will likely increase the worth of a home. A shoddy bathroom or kitchen remodel can drive home value down.
Why home equity matters
Home equity is a measure of wealth. Homeowners can allow equity to remain in their home or pull the money out and use it for something else.
Often, home equity is used as a down payment on a new home. The larger a home buyer’s down payment the lower they can keep loan expenses and monthly payments.
Another way homeowners frequently tap home equity is by borrowing money through a home equity loan or a home equity line of credit (HELOC).
How home equity loans can be used
Home equity loans are popular because they can be used for anything you wish. Kitchen remodel? Vacation? Tuition? Yes, yes and yes! A home equity loan is one of the most flexible financing tools available to homeowners.
When you choose to access cash through a home equity loan, keep in mind that your home serves as collateral. Also, if you sell the home the loan’s balance will be due when the sale closes. Homeowners who sell and have an outstanding home equity loan balance typically pay off the loan from proceeds of the sale.
All loans subject to approval. Rates, terms, and conditions are subject to change may vary based on credit worthiness, qualifications, and collateral conditions.