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What Is A Home Equity Loan and How do They Work?

Reviewed by: David Naimey

Approved by: Chad Turner

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Home equity is a topic that may sound more complicated than it actually is. Due to questions we’ve had, we’ve decided to make a blog post talking about what equity is, how it’s helpful to have, what you can do with it, and how it affects the home buying process! We’ll also throw in some tips on how to increase equity in your home!

What is Home Equity?

Equity is a mortgage loan term that describes the numerical portion of the home you actually own. In a much simpler phrase, home equity is essentially the value of your home, compared to what you still owe on it. When you originally buy a home, if your home has an appraised value at higher than your loan amount, you essentially already have positive equity. This is also a really good thing to have, especially if you have positive equity in your home before closing on it. Home equity can be increased by the raising of market values of homes in the area, home improvements, purchased directly with your down payment on the home, and by continually paying your mortgage payments. All of these elements can give you more equity in the home over time.

How Is Having Home Equity Helpful?

The equity in your home is considered one of your assets. Once you’ve paid closing costs and started making monthly payments, you slowly increase the amount of equity you have in your own home. After a few years of payments, you can use your home equity for several different things. For example, you can take a home equity loan out, which may have better interest rates than personal loans of the same magnitude. Some people decide to take equity home loans to help pay for home improvement projects through the use of a cash out refinance. Some people decide to use that equity to help pay for the college tuition of one of their children, or help their current credit score by paying off interest debts and credit cards. Another benefit are home equity loans. Home equity loans can be a lump sum at fixed rates given to you against the equity of your home.  Just like a regular loan, you can take out an amount and pay it back slowly over a term, using your home equity. It can be very useful to help cover any emergencies that may need more money than you have in your savings to cover.

How Does Equity Affect The Home Buying Process

Essentially, equity can be seen as the value of your home versus the amount of money you owe on it. In other words, equity in your home can be very beneficial, and the more of it you have, the more valuable your property actually becomes. If you buy a home that appraised higher than your loan amount, your home is already giving you a return investment on your purchase by having more equity. For example, If you’ve spent $20,000 on a $100,000 home, you have 20% equity in it, if all things remain the same. You only own around $20,000 of this home as it stands. However, if your home shoots up to $200,000 in value, the amount of your equity or “ownership” of that home also increases. This is a fantastic spot to be in, because after a shorter period of time of home ownership, you’ll be eligible for a larger cash out refinance, leading to the ability to have a nice lump sum of extra money if you choose to.

Time For Math!

If you want to find out the percentage of equity you own in a home, divide the current amount of the value of the home by its current market price. Now subtract this number from 1, and multiply by 100% to get a percentage. For the above example we did a $20,000 down payment on a $100,000 home, which leaves the remaining debt on the home at $80,000. We also have the new appraised value of the home being $200,000. Now we take these numbers and do this: 1 – ($80,000/$200,000) =  1 – (0.4) = 0.6 x 100% = 60% This means that your ownership of the home went from 25%, the amount of your down payment, to a whopping 60% of interest! This is wonderful and puts you in a good place to take some decent money out! Hopefully we’ve simplified what home equity is a bit, as it’s a tougher mortgage term. If you have any further questions, feel free to comment!
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