Some real estate jargon can be hard to pin down, like the concept of home equity. Most people know it’s a good thing to have, but when it comes time for the actual definition, well…That’s when things start to get a little murky.
Sound all-too-familiar to you? We’ve taken the liberty of breaking down home equity to its simplest terms. Read on below to learn what it is, what it’s used for, and how to build it to your advantage.
So, what exactly is home equity?
Put simply, home equity refers to the percentage of your home that you own outright. Since you’ll likely have to take out a mortgage in order to buy a home, unfortunately, you don’t own it in full from the moment you close. Instead, the lender also has a controlling interest in the property, which gets smaller as you pay off what you owe. As you pay down your debt, your stake in the home grows and you can use that value — your equity — to offset other expenses if needed.
“Think of home equity as the amount of money you would take from your home sale if you were to sell it today,” says Sep Niakan with HB Roswell Realty. “It’s the amount of money that would go in your pocket after paying off all your debts and closing costs.”
As an example, if a home is worth $200,000 and the seller has $150,000 worth of combined debt on the home (mortgages, home equity lines of credit, etc.) then he or she owns $50,000 worth of equity in the home.
That money can then be used as an asset to build wealth in other areas, such as buying another home, financing kids’ colleges, or saving for retirement.
How to build home equity
That said, your potential for equity doesn’t cap itself at the amount your home’s purchase price. If you do the right things as a homeowner, you can work to build your home’s equity beyond what you paid for it, making it a profitable investment.
As for how to get there, in addition to reducing the principal amount that you owe on your mortgage, Roh Habibi of The Habibi Group and Bravo TV’s “Million Dollar Listing San Francisco” stresses the importance of ‘sweat equity’.
“Other aspects of home equity are based on improvements and remodeling that has been put into the home,” he says. “The biggest returns on investment we have seen is kitchens, bathrooms, and some may argue great landscaping.”
Just as Roh points out, your potential for earned equity increases with your home’s market value. On the one hand, you can increase the value through improvements, but it will also increase on its own if you live in an appreciating area. With that in mind, make sure choosing a good location features prominently in your home search.
How to use your home equity
It can be helpful to think of your home equity in the same way that you would credit. Selling your home and receiving a lump-sum of cash in return is one way to utilize that credit. The other is to take out either a home equity loan or home equity line of credit.
Tamara Celete, an agent with Sweet Life Realty Group shared a story about one of her clients who chose the first option. “Mary was an older woman struggling to make ends meet,” she explains. “After her granddaughter convinced her to sell her home, and after she paid off a small mortgage amount, she had about $250,000 in equity. With that, she was able to pay off debts, buy a small condo in a 55-and over the community, and she no longer had to work in order to pay the bills each month.”
The latter option is a bit more complicated.
Home equity loans and lines of credit treat your home’s value as a guarantee of repayment. With home equity loans, you’re given a lump sum, which will be repaid over the coming years in a flat, monthly amount, much like a standard loan. With a line of credit, you have a specified amount of time during which you can borrow money against your home, as need. You’ll make modest monthly payments during that time, and, after it ends, enter a repayment period where you’ll truly begin to pay off the debt. That said, it’s important to be careful with either option. Failure to repay your debt can result in foreclosure of your home.
This article originally appeared on OpenListings.
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