Home equity is another real estate term that often confuses homeowners. But when you take the time to understand what it means, how it’s calculated and used, and why it’s important to you, it can become extremely valuable.
What is home equity exactly?
Simply put, home equity is the most valuable asset for a homeowner.
It comes from a homeowner’s interest in a home. It’s the difference between your home’s fair market value and the outstanding balance of all the liens on the property.
In other words, home equity is the difference between the appraised value of a home and what you owe on it.
It’s calculated by taking the value of your home and subtracting the amount of money you owe on mortgages. Although you are a homeowner, if you still have money owed on your house, the lender you borrowed money from to purchase the home has interest in the property until the full amount of the home is paid off.
Use our free valuation tool to find out how much your home is worth.
How is home equity used?
Equity is part of your total net worth, therefore you can use it to take income or lump sum withdrawals from someday. You can also pass it onto your heirs and to buy your next home.
By getting a home equity loan, also called a second mortgage, you can use the money from that on anything, such as home improvements or a long-term investment in your future. You can also use equity to fund your retirement by using a reverse mortgage, which doesn’t require monthly payments and provides an income to retirees.
Another thing home equity is used for is to help a lender determine your loan to value ratio. Referred to as LTV, your loan to value ratio is used when determining whether to approve your application for a loan. It also determines whether you have to pay for private mortgage insurance (PMI).
How do you earn home equity?
The more equity you have, the better. There are two ways to increase home equity – if the value of the property you own increases from the original price you bought it for, or if you pay down your outstanding loan balance.
Why is home equity important to you?
Have you ever heard people say that being a homeowner builds wealth? Home equity is how this is done.
Building home equity takes time, and having more equity is a good thing. As your home begins to build value over time through market value, home improvements and making payments toward what you owe, it becomes more of a financial resource to you.
Although it might take some time to understand, home equity is an important term to know as a homeowner. Understanding how it’s used, how it’s earned, and how it can benefit your financial future is so important.
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