Understanding Home Equity: What It Is, How To Calculate It & How To Use It
You probably hear people say all the time that one of the biggest advantages to buying versus renting is that you start to build equity.
When you hear that you might think, “okayyyy, but what the heck is equity?!”
And that’s a valid question because equity can be something that's talked about, but you may not fully understand its value.
As your friend in real estate, I’m here to make sure you understand the ins and outs of buying and owning a home so that you can reap all of the benefits that come with both!
Grab your pen and paper because it’s time for another real estate 101 lesson and this time it’s all about home equity.
We’re diving into what it is, how to calculate it and what to do with it!
What Is Home Equity?
Put simply, your home’s equity is the difference between how much your home is worth and how much you owe on your mortgage.
Throughout the duration of your home ownership, the equity that you build will fluctuate and it’s based on a few things, including:
Your initial down payment
Your mortgage payments
The overall market value
Improvements to the home or property
The whole concept of equity is why real estate purchases are considered to be an appreciating asset, meaning the value of the investment increases overtime.
Depreciating assets on the other hand, such as boats, cars and RV’s, do the exact opposite.
This is also one of the main reasons that real estate agents encourage you to buy versus rent because when you’re renting, you are not seeing any equity gains.
In fact, I would say that in addition to your rent payments, you’re losing even more money due to so many non-refundable fees, like security deposits, renewal fees, pet fees and more.
With that said, it does need to be the right time for you to buy, but the moment that you can make the move, I encourage you to do so, so that you can start building equity and use it to your advantage in the future.
How To Build Home Equity
When you buy a home, you instantly start building equity because it all starts with your down payment and your mortgage.
The more you put down on your home, the larger percentage of equity that you build right off the bat AND you lower your monthly mortgage payment.
Each time you make a payment, you gain more equity! Aside from your payments, you also build equity through appreciation.
When you buy a home, it’s valued at one amount, but the longer that you own the home, its value will typically increase.
On average, your home will appreciate 3% each year, so here’s what this looks like in action:
Let’s say your home is worth $400,000 - this is the average price for a single family home in certain parts of Billings right now!
3% of $400,000 is $12,000, so you can expect that your home would be worth $412,000 by the end of that first year. And it only goes up from there. 📈
This is why it’s so important to consider any home renovations or improvements that you do because you don’t want to risk losing any of this appreciation. With that said, there are some projects that increase the value even more - I break a few of those down in this blog post.
How To Calculate Your Home Equity
So, now you might be thinking… “this whole equity thing is really freaking cool - so how do I know how much equity I have?!”
Great question! And good news - it’s pretty simple ⬇️
There’s two things you need to know in order to calculate your home equity:
Your current loan balance
Your current home value
To determine your current loan balance, you can use the balance on your latest statement - you just need a rough estimate in order to calculate this!
And for your current home value, you can use this handy dandy Home Evaluation Tool, but if you’re wanting exact numbers, contacting your realtor for a market analysis will be your best bet.
Once you have those two numbers, here’s the formula:
Your Current Home Value - Your Loan Balance = The Equity In Your Home
What Can You Do With Your Home Equity?
Finally, once you know what your home equity is, you might be wondering what exactly you can do with it and more importantly HOW to use it.
Here’s the cool thing about your home equity: there are little to no restrictions on how you use it!
When you own a home and you’re making mortgage payments, you’re essentially building yourself another savings account and how you use it is up to you.
The key, however, is that you’re using it wisely and in a way that will continue to build your wealth versus using it for things that aren’t going to contribute to your financial health.
After all, you’ve worked so hard to earn this extra money, so you don’t want to throw it away right?
Here’s a few of the most common ways that people use their home equity:
Pay off credit card debt
Consolidate your debts
Invest in home improvements or additions
Purchase an investment property
Start a business
Emergencies
I talk about each of those more in this blog post, but you can see that your home equity is truly meant to continue growing your wealth so that you can experience even more equity in the future!
But don’t get it twisted - these aren’t the ONLY ways that you can use your home equity.
One of my favorite equity stories was one of a family utilizing the equity in their home to pay for an adoption - my heart absolutely melted on the spot. 🥰
And this is why I’ll keep shouting home ownership from the rooftops because it’s SOOOO much more than your dreamy backyard or fancy kitchen. It’s about the way it contributes to your future and sets you up to impact your future generations!
“Okayyy, but how do I access this home equity??”
3 Ways To Access Your Home Equity
1️⃣ Cash Out Refi - this is exchanging your mortgage for a new one.
This type of refinance has typically a higher interest rate, but you will receive a check once the refi closes. This option is great especially if your interest rate is currently higher than the refi rate - no loan to pay back, just a new mortgage payment + cash money in your pocket. 💸
2️⃣ Home Equity Loan - also known as a second mortgage.
This is a whole new loan with a new payment and its own fixed interest rate. You will also get the money in lump sum. Your current mortgage stays the same, you will just have the “second mortgage.” Depending on your lender, they will typically lend on 80% of your equity.
3️⃣ Home Equity Line of Credit - aka the HELOC.
This is a line of credit borrowed against the equity in your home and you can draw on it if you like. Interest rates are often lower than home equity loans, but they are variable meaning the interest rate can change. This is a great short term option for projects or emergency funds.
Well there ya have it, friend - the 411 on home equity. My forever motto is that educated people make smart moves (literally 🏡) which is why this blog exists.
To recap - we summarized home equity and what it is, how to calculate it (Home Evaluation Tool Here!), what you could use it for and how to access it!
When you know what’s possible for you, you can confidently take action and THAT is what I’m here for.
If you have more questions about home equity, I’d love to chat it out - my DM’s are always open. 💌
