What Do Homeowners Need to Know About Home Equity?

Aside from having a comfortable shelter for the family, building home equity is one of several reasons why many people buy a home. Over the years, homeowners who dutifully repay their monthly mortgage in a timely manner should know that they can reap the rewards on their investment especially during this time that the country’s housing industry continues to get better.

Home equity explained

In simple terms, home equity is the amount homeowners put on a down payment when taking out a mortgage to buy a home. It’s the value of the home that the homeowner truly owns against the amount owed to the lender. For example, if a person buys a home with a fair market value of $300,000 and puts a 20 percent down payment, the buyer has a $60,000 worth of home equity (i.e. $60,000 is 20 percent of $300,000). Aside from the down payment and the amount repaid over time, homeowners should also know that there are external factors that could affect home equity.

Several ways homeowners can utilize home equity

According to a recent ATTOM Data Solutions report, in the fourth quarter of 2019, there were 14.5 million residential properties in the U.S. that were considered “equity-rich”. The property data provider defined “equity-rich” as homeowners having 50 percent or less estimated loan amounts secured by their homes.

Homeowners who have built a significant amount of home equity have several options on how to take advantage of their home equity. 

1. Use a bridge loan to buy a new home

Homeowners who want to buy a bigger home may qualify to use a bridge loan so that they don’t have to worry about selling their current home first before they can make an offer. A bridge loan allows homeowners to access their home equity when they make their home available in the market. Eligible bridge loan users can buy a new home and move in right away, eliminating any stress along the way. In a continuous housing market boom, a bridge loan could give a homebuyer an edge to compete with first-time buyers. Although homeowners who have a significant amount of home equity may find it ideal to use a bridge loan, they still need to meet lender requirements to qualify.

2. Use home equity to take out a second mortgage

Another way to take advantage of home equity is to apply for HELOC or Home Equity Line of Credit. HELOC is a type of a second mortgage that a homeowner may consider. Taking out a second mortgage allows homeowners to use home equity to borrow a significant amount of money. Second mortgages allow homeowners to draw money from their home equity and use it to consolidate debts, pay for education or make home improvement projects. HELOCs often have lower interest rates as compared to other types of debt and tax benefits that’s why some homeowners consider it.  

3. Turn home equity into cash upon retirement

Elderly homeowners who don’t have relocation plans for the rest of their lives may take advantage of their home equity by taking out a reverse mortgage. It’s a type of mortgage designed for borrowers age 62 years old and above. It’s like taking out a second mortgage, but the only difference is that reverse mortgage borrowers don’t have to repay the loan as long as they live in the same home. In a reverse mortgage, the elderly borrower receives payments from the lender, which adds up to the loan amount. Reverse mortgage borrowers could either receive a lump sum amount or in a credit card-type loan and enjoy the funds during retirement. Eligible reverse mortgage borrowers may want to use a calculator from the National Reverse Mortgage Lenders Association to give them an estimate of how much they could get.

There are renovation projects that can increase home equity

Aside from putting a large down payment, making timely mortgage repayments, and making extra payments towards the principal, improving the home through renovation projects could increase home equity. Installing fiberglass doors to improve energy efficiency is just one of the few renovation projects that could increase the home’s value and make homeowners happy. Some homeowners even tap their equity to fund a renovation project to add value to their homes.

Other factors that could affect home equity

There could be instances when home equity fluctuates, even when homeowners are up to date with their monthly mortgage payments. Market value is one of the factors that could affect home equity. Home condition, neighborhood, and prevailing property price in an area could either increase or decrease home equity. Moreover, homeowners could even lose home equity when the fair market value of their homes has become less than the balance of the principal amount of their mortgage loan. It’s called an underwater mortgage. The 2008 national housing crisis where home values have deflated put millions of borrowers’ mortgages underwater.

Historically low mortgage interest rates and tight competition among millennial homebuyers are just some of the few signs that the housing market will continue to be in good shape.

It’s possible for homeowners to get an estimate of home equity

Homeowners who plan to squeeze funds from their home equity may want to initially get an estimate of how much home equity they have before speaking with a loan advisor. A lender typically will not approve any loan application that uses home equity if the homeowner’s mortgage is underwater.

Initially, homeowners need to know how much they owe from all the mortgages they have by requesting a payoff statement from their servicer. It’s a detailed document that lets homeowners know everything they have to pay including the dates. The next step is to have an idea of the home’s market value. Browsing Zillow.com or any other online listing sites can give homeowners an approximate price of recently sold homes around their area. Another way to learn market value is to speak with real estate agents. For serious homeowners who want to tap their home equity to buy a new home using a bridge loan, hiring an appraiser could be an option.

To find out how much home equity a borrower has, simply subtract the total amount of mortgage balance from the home’s current market value. The mortgage is underwater if the computation brings a negative result.

Speak with a loan advisor when accessing home equity

Homeowners who have a substantial amount of home equity can access and use it in various ways. When using home equity, it’s important for you to make a sound financial decision because you’re using your home as collateral when taking a loan. Speak with a professional loan advisor today to learn more about your options on how to maximize your home equity.