What is Home Equity (and Why Should I Care)?
While the perks of "a place of your own" span the gamut (from decorating to privacy), the real ownership advantage lies in a single two-word phrase: home equity.
What is Home Equity?
For such a jargonized real estate word, home equity is one of the more simple (and pleasant) terms in home ownership. Simply put: home equity is the portion of the home that you actually own – the part that you've technically paid off via your monthly mortgage payments thus far. If you've spent $10,000 on mortgage payments, you own $10,000 worth of house. If you've paid $100,000, you own $100,000. Simple math, eh? The rest still technically belongs to the bank (or lender) who handles your mortgage.
How Much Equity Do You Have?
The amount of equity you have in your home determines what you’d stand to earn if you sold the home right now. It’s the value of your home minus the outstanding balance you currently have on your mortgage loan.
An example: Say you’re considering putting your home on the market. Your realtor does market research and determines the property is worth about $220K, given local comps. You check with your mortgage lender, and you currently only owe $110,000 on your existing loan (which you took out 10 years ago.) In this situation, you have a 50% equity stake in your home. If you were to sell right now, about half of the revenues from the sale (less closing and agent fees as applicable) would go straight into your pocket. That’s $110,000 … in profits.
The Simple Truth
Equity is a big deal, and it’s one of the most important reasons to buy a home instead of renting one. The more equity you have, the more you stand to make when the home is sold – whether that’s today, tomorrow, or even once the property is passed on to a loved one.
You can increase your equity over time by making more substantial payments toward your loan, or you can wait until market conditions improve. As the market improves and your home’s value appreciates, your equity stake follows suit. (This is why working with a Realtor on your sale (and its timing) is crucial!)
Profits, HELOCs & More
Though equity can equal a big payout when you sell your home, it's not the only benefit of having a serious stake in your property. You can also use home equity to take out what’s called a HELOC, or Home Equity Line of Credit. HELOCs allow you to essentially borrow against your home equity (as collateral) to acquire funds for college, retirement, renovation projects, or other long-term investments.
No matter your intentions (be it a HELOC, selling your home, or passing the property on to a family member), home equity is the key to getting the most from your transaction.