Those monthly mortgage payments might feel more like chipping away at a boulder than removing it altogether, but homeowners can take heart that each payment does mean a little more ownership in their property.
Just how much ownership—or equity—does a homeowner have? Grab a calculator, and take note. There’s more than one factor in calculating a home’s equity.
Read on to learn how borrowers can determine how much of their home they own, and what else they can do to increase their home’s equity in addition to leveraging it as part of a borrowing strategy.
What Is Home Equity?
Simply put, home equity is the difference between the value of a property and the outstanding balance of loans, mortgages, liens, or other debt on the property. For homeowners, home equity typically starts to grow these ways:
• The down payment. With an FHA Loan, homeowners may be able to pay as little as 3.5% down on their home . However, the larger the size of the down payment, the more equity a homeowner has right off the bat. More than half of all homebuyers put an average down payment of less than 20%, but a larger down payment could mean more favorable mortgage rates.
• Making monthly mortgage payments. With every mortgage payment, homeowners are paying down the amount they owe, building ownership slowly over time. To build home equity faster through mortgage payments, homeowners could pay more than the minimum each month, or make biweekly payments to add a mortgage payment each year.
• Keeping an eye on property values. In a particularly hot real estate market, a homeowner might gain equity simply through rising property values. If a homeowner’s property value rises, so, too, does their equity in the property. Homeowners can determine the market value of their home through a formal appraisal , or the Federal Housing Finance Agency’s house price index calculator .
• Making home improvements to increase property value. Instead of waiting for property values to rise, or contributing more towards monthly mortgage payments, homeowners might also decide to take on improvement projects that increase the home’s value.
Recommended: Top Home Improvements to Increase Home Value
For homeowners, knowing their property’s estimated value, in addition to their equity in it, off the top of their head is more than a fun party trick. For many Americans, purchasing a home will be the biggest expense of their life.
Understanding how much of their home they actually own may help them tap into the home’s value by borrowing against it. Once an owner knows how much equity they have, they know how much of a home equity loan they can secure.
How Do You Calculate Home Equity?
Homeowners can estimate their home equity on their own in one of two ways.
Using Your Current Mortgage
One way to calculate it is by using the numbers from their mortgage for an estimate. Find the amount of money withdrawn for the mortgage when the loan originated, then simply subtract the current amount due on the mortgage from that figure.
The difference is a rough estimate of the amount of equity available on the home. However, if a home has appreciated in value, the homeowner likely has more equity available.
Asking Your Lender for an Appraisal
To get a definitive calculation on home equity, homeowners should contact their mortgage lender. Lenders will typically conduct an appraisal to determine the home’s current value, then gather the homeowner’s documentation to give an exact number.
To estimate home equity while taking property appreciation into consideration:
1. Find an online value estimator tool or most recent property appraisal figure. This is the current market value of the home, which may have appreciated since the property was purchased.
2. Subtract the current amount still due on the mortgage from the above figure.
The difference is a rough estimate of the equity available on the home, factoring in property appreciation.
Both of these calculations can be a helpful tool to begin exploring a homeowner’s equity, but neither are precise measures. If a homeowner wants their exact home equity, they’ll need to contact their mortgage lender and request an official appraisal.
Pros & Cons of a Home Equity Loan
A home equity loan is a loan with the home as collateral. Homeowners can pull only the equity they’ve gained on the value of the property, not the outstanding mortgage amount.
Typically, the proceeds of a home equity loan are paid as a lump-sum payment. Like any loan, home equity loans come with pros and cons. Advantages might be:
• Benefits homeowners who have significant equity. If a homeowner has paid down a significant portion of their mortgage, or their property has dramatically appreciated in value, they can draw down on a potentially large amount —sometimes more than they could with a personal loan.
• Fixed monthly payments. Home equity loans are typically fixed rate and will have a fixed, monthly payment throughout the life of the loan (typically 5 to15 years).
• Tax-deductible. When used for certain purposes, interest payments on home equity loans are tax-deductible .
• It can be used for anything. While a homeowner is borrowing against the value of their property, a home equity loan can be used for anything, not just home improvement.
Home equity loans can be a great tool for homeowners, but they do come with potential drawbacks:
• Closing costs. The process of taking out a home equity loan is similar to taking out a second mortgage, which can mean hefty closing costs. On average, a homeowner can expect to pay between 2% and 5% of the loan’s amount during closing .
• Home as collateral. When a homeowner takes out an equity loan, they’re putting up their property as collateral . In the event that a homeowner gets behind or defaults on their loan, there’s a chance they could lose their house.
• Additional mortgage amount. Using the equity in a home that has been built up over time means that cushion is gone until the loan is paid. If real estate values decrease and the property is no longer worth the amount it’s mortgaged for, the owner will be “underwater” or “upside down.” If there is a need to sell the property, mortgage options for properties that have negative equity are limited.
• It can be used for anything. Yes, this can be both a pro and a con. It might be worth keeping in mind that the loan still has to be paid and the funds should not be used frivolously.
Home equity loans aren’t the right fit for all homeowners, and the risks should be considered before taking on the debt. However, for the right project and homeowner, a home equity loan could be the perfect fit.
Recommended: How Much Home Equity Can You Tap Into?
Home Equity Loan Alternatives
If a homeowner doesn’t want to take out a home equity loan but needs cash, there are some alternatives.
For anticipated expenses down the line, they might consider a Home Equity Line of Credit (HELOC). Unlike a home equity loan’s lump sum, a HELOC allows owners to pull from their property’s equity continually over time. Borrowers can take only what they need at the time.
But HELOCs also use the home as collateral, which might not appeal to all borrowers. If a homeowner prefers an unsecured loan, they might want to explore personal loans. Instead of the interest rate being determined by home equity, personal loans factor in a borrower’s credit history, income, and employment.
Something else to take into consideration is that these lines of credit typically have a variable interest rate instead of a fixed rate, which means that the loan payment may be different each month.
Qualified borrowers in search of a cash infusion that doesn’t require collateral and has a fixed interest rate may want to consider an unsecured personal loan for home improvements from SoFi.
A personal loan, like a home equity loan, can be used for many purposes, including home improvement projects, with loan amounts between $5,000 to $100,000 with a low fixed rate and no fees.
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