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Understanding Home Equity

Published April 29, 2019

seesaw with bags of money to illustrate concepts of equity and reverse mortgage

What is Home Equity?

Home equity is the amount that your home is worth minus any outstanding mortgage loan balances. For example, if you purchase a home valued at $200,000 with a $150,000 mortgage, you have $50,000 equity in your home. Your home equity will most likely grow over time as the value of your home increases and as your loans are paid down or reduced.

However, be advised that there are no guarantees your property values will increase.

In the event of economic downturn, like the 2008 mortgage and banking crisis, your home could lose value, and therefore, you’d lose your equity in the home until markets rebound. This means your investment could hold less valuable — and you’d still have to make your mortgage payments as planned lest you default on the loan.

There are two factors that create equity.

The first is related to appreciation, caused by inflation or improvements to the property. The second is the continuing process of paying off the principal you owe on your first mortgage. It is important to understand how home equity can be established and built.

Why is Equity Important?

Your home equity starts as soon as you purchase your home. Your down payment acts as your initial equity stake, which today could be as low as 0%. Most homeowners start with at least a 5% home equity stake. Most lenders won’t allow you to access any borrowable equity until you have more than a 10% ownership stake in the property. If your equity stake is small, it can easily be erased by a small downturn in property prices.

Your equity stake grows every month with each payment you make on your loan. By doing this every month, you retire a little bit of the loan’s principal, bringing you that much closer to owning your home. This is your equity stake, growing in small increments every month. Most home loans are standard amortizing loans which require equal monthly payments. These payments go toward both the interest and the principle on the loan. Over time, the amount that goes toward the principle increases every year. As you build equity in your home at an increasing rate, the longer you stay in your loan, the more quickly you build equity.

Paying toward your mortgage every month isn’t the only way to build equity. When your home gains value, your equity grows. If your neighborhood increases in value or you make some improvements to your home, you gain equity on your property.

How Does it Relate to Debt?

Equity is classified as an asset and is counted as part of your total net worth.

The Danger of Home Equity Loans

Be advised — CreditGUARD is not an advocate of home equity loans or any new loans.

Taking out a loan against the value you’ve paid into your property carries significant risk, as you still have to pay your mortgage payment AND a new loan payment. Failure to repay your home equity loan can result in foreclosure and heartbreak.

Despite the obvious danger here, some homeowners choose to take a home equity loan out to pay off other high-interest personal debt such as a car loan or credit card debt. Some may choose this option to pay for education or consolidate other forms of debt. The most important factor in choosing to take out a home equity loan to pay off other debt is to make sure that you are not borrowing more than you need and that what you are paying off has a larger interest rate than the home equity loan.

In addition to home equity loans, there may be the option of a complete refinance, which could lower your interest rate on the whole loan (if the rates have gone down, and potentially get the money you need at the same payment (because of the lower rate).

If you’re behind on your credit card payments, don’t put your home at risk, too.

Call CreditGUARD today to learn how we can help you with your credit card debt in a way that doesn’t jeopardize your home and can help you move toward freedom without any new loans. Just make one easy monthly payment and get out of debt faster. Call CreditGUARD today at 1-800-500-6489.

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