Every time you make a mortgage payment or if your home’s value rises, you build your home's equity. But what is equity? It’s the difference between what you owe on your mortgage and what your home is currently worth.
Here is an equity example: You owe $250,000 on your mortgage and your home is worth $350,000. You now have $100,000 of equity in your home. If you owe $150,000 on that same home, your equity is an even higher $200,000.
Why does equity matter? Equity is important when you sell your home. The more equity you've built, the greater the profit you earn from your sale.
Say you owe $100,000 on your mortgage when you are selling. If your home is worth $380,000, you might sell it for that amount. That means you’d potentially earn $280,000 on your sale; your home’s sale price minus the remaining amount you owe on your mortgage is what you will realize from the sale.
Of course, it’s not that simple. You’ll still have to pay a commission to your real estate agent, usually a percentage of your home’s final sale price. You’ll also have to pay closing and settlement fees on your mortgage, which will eat into your profit. But the more equity you have, the more you'll typically make on your home sale.
You can borrow against your equity too. Another perk of building equity? You can borrow against it in the form of home equity loans or home equity lines of credit.
How much you can borrow depends on the amount of equity you’ve built. You can typically borrow up to a certain percentage of your equity. If you have $100,000 in equity, for instance, you might be able to borrow $70,000 in the form of a home equity loan or line of credit. You can use the funds from these loans to pay for anything, including home repairs or renovations or your child’s college tuition. You could also use these loans, which generally come with lower interest rates, to pay off your high-interest-rate credit card debt.
Home equity loans: In a home equity loan, you receive your payment in a lump sum that you pay back with interest in regular monthly payments. Be sure to make these payments on time. If you default on them, your lender can initiate foreclosure proceedings against you.
Home equity line of credit: Better known as HELOCs, home equity lines of credit act more like a credit card, with your home’s equity serving as your credit limit. You only pay back what you borrow. You might have a home equity line of credit for $70,000. But if you only borrow $30,000 to fund a kitchen remodel, you only pay back that amount.
How do you build equity? There are two ways to build equity. First, every time you make a mortgage payment and pay down your loan’s principal balance, you steadily build equity. Second, your equity will automatically increase if your home’s value rises. That’s because the market value of your home will be that much higher when compared to the balance of your mortgage.
When you make that mortgage payment each month, know that a portion of it is going toward building up your home’s equity and your overall wealth. That might make sending that payment each month a little easier to take!