Owning a home is a quintessential part of the American Dream. In addition to being a place for a family to call their own, it is also a key component to building wealth over time. That wealth is built through home equity which is often a better investment than the stock market, because nationwide average annual home appreciation is consistently around 3%, excluding the past few years, due to the COVID-19 pandemic.
But what specifically is home equity, why is it important, and how do you build your equity?
What is home equity?
Home equity is the difference between how much your home is worth and how much you owe on your mortgage. As you make payments on your mortgage loan, you reduce your loan amount while at the same time build your equity.
For example, let’s say you buy a $550,000 home with a 10% down payment of $55,000. As soon as you close on your home, you would have $55,000 of equity in your home. As you make mortgage payments, you are paying down the principal balance of your loan and increasing your home equity. When your mortgage is 100% paid off, you have 100% equity in your home.
Why is home equity important?
First and foremost, building home equity is important because it is a long-term strategy for building wealth. As your home appreciates and your principal loan balance decreases, you can increase your financial stability through homeownership.
Additionally, you can use your home equity for different things, including to lower your mortgage payments, make home improvements, and pay for tuition.
How do you build home equity?
There are two ways to build equity in your home: paying your mortgage and appreciation—the increase in value of your home over time.
Each month, as you make mortgage payments, you will decrease the amount of money you own on your loan, increasing your home equity.
Using the previous example, let’s say you pay $2,000 on the principal loan each month. After ten years, you would have paid $200,000 plus the initial $55,000 down payment, leaving $295,000 on your principal mortgage. Using the basic formula of home worth minus what you owe, you would now have $255,000 in home equity.
However, appreciation also affects equity, and in Northern Virginia, it’s safe to assume your home value increased over those ten years. While property values can go up and down, the compounded home appreciation in Northern Virginia over the last ten years is at 37%.
In our example, if your home appreciated just 3.20% annually, your home’s value would increase from the purchase price of $550,000 to $753,500 after ten years.
Now, with your new home value of $753,500 minus the $295,000 you still owe on your mortgage, your home equity—factoring in your mortgage payments and appreciation—would be $458,500!
As you can see in our example, by buying a home in an area with historically fruitful appreciation, keeping your home in good shape, and making consistent monthly payments, your home equity can help you build wealth and create long-term financial stability.
How do I get access to my home equity?
Home Equity Line of Credit(HELOC)
With a home equity line of credit, you are able to open a line of credit tied to the equity in your home and use it for things like home improvements, tuition, paying off debt and more. Lenders typically allow you to borrow between 80 and 95% of your home’s equity.
“Cash Out” Refinance
Another way to access the equity in your home is through a cash-out refinance, which will allow you to pay for home improvements, make other purchases, or pay off other debt. Because mortgage interest rates tend to be much lower than interest rates on other forms of debt such as credit cards or personal loans, a cash out refinance can be a much smarter way to accomplish your goals.
4 ways to use your home equity
1. Remove Private Mortgage Insurance (PMI)
While a 20% down payment was once the standard, new home buyers can now buy a home with little to nothing down depending on the type of loan, credit score, income, and military status. However, most mortgage lenders require homeowners to purchase private mortgage insurance (PMI) if you don’t put at least 20% down. PMI is protection for the lender in case of default and most homeowners will refinance as soon as possible to eliminate that extra burden.
With a conventional loan, PMI is automatically canceled once you reach 22% equity in your home, however, you can request that your lender cancel PMI when you reach 20% home equity.
By removing your PMI payment, you’ll reduce your monthly mortgage cost and keep more money in your pocket—or you can put the money you’re saving from no longer paying for PMI towards your loan principal to decrease your balance and increase your equity.
2. Make Home Improvements
Not only will it help you improve your living space, but it also builds value in your home if you improve the right things. We can help you strategize on where your biggest returns are should you decide to update or renovate your home.
3. Pay For Tuition
With the ever increasing price of college, student loans are often becoming more necessary. But student loans aren’t always the lowest-interest way to finance college tuition. You can use your home equity to get cash to help cover tuition, books, and room and board with lower interest rates than traditional student loans, letting your home equity work for you.
4. Pay Off Debt
If you hold credit card debt month over month, it’s worth considering paying the balances off. Most credit cards charge high interest rates, which means your balances increase every month. Make sure if you decide to use your home equity in this way, you don’t go charging up your credit cards as soon as they are paid off.
Are you interested in a personalized home equity analysis built just for you? Our agents are ready to show you just how much your home equity has grown and how much you might have benefited from this crazy housing market.