Home Equity is a very common term, but not many people know what it is and how it can be used to get some financial aid. In this article let’s discuss what home equity is and why it is so important
What is Home Equity?
Home Equity is the current market value of your home excluding the amount you owe to your lender. It can increase over the time if the property value increases or if you pay down your mortgage loan balance quickly.
In other words, home equity is the portion of your home that you truly own. As your lender has an interest/share in your home until you pay off your mortgage money. You can say that home equity is the most valuable gain that you get from home ownership. This asset can be used for various purposes so it is really important that you understand how it works and how it affects your financial freedom.
Why is Home Equity Important?
Home equity can be considered a long-term planning for building wealth. It is a mechanism by which you can convert your most valuable asset into cash should the need arise. It might not be the cash in the bank but it is most definitely the next best thing.
This home equity can be used by homeowners for different purposes. For example, to pay off college tuition, to invest in some business, to pay for your medical treatment and so on. In short, home equity can help you in your difficult times by making available some extra cash in the hour of need.
HOW DO YOU BUILD HOME EQUITY?
Building home equity is a bit like investing in a long-term instrument which means your money, for the most part, is locked up and not spendable. Building equity is a primary financial benefit of home ownership. There are two ways that you can build your home equity
- Increase the Value of Your Asset
You need to increase the value of your asset that you own. There are a number of ways that you can do this. Making home improvements is the most effective way that people use to increase equity in their home. However, it is important to realize that not all home renovations will increase your home value.
So, you need to consider different renovation options and invest in those that you are certain will benefit you and will increase your home equity. Another plus point in investing in home renovations is that you get to enjoy the improvements as well.
- Decrease Debt
Another way that you can increase your equity is by decreasing the debt on your asset. There is a strategy that you can use to pay down your debt and increase your home equity. Biweekly payments are a straightforward way to decrease any type of debt. In this particular case, it will build your home equity quickly and will decrease the overall interest rate that you will pay over the lifespan of your debt.
Biweekly payments on your home mortgage would help you to stack the deck in your favor in case you need to sell your home early in your loan term. These biweekly payments are particularly more useful for loans who have longer loan terms and the loans that carry a high interest rate.
Type of Home Equity Loans
There are two basic types of home equity loans
Fixed-rate home equity loan
A fixed-rate home equity loan is pretty straight-forward. The lender provides one lump-sum to the home buyer, which needs to be repaid over a period of time with a set interest rate. The monthly payment and the interest remain the same over the life of the loan. The loan-terms for fixed-rate home equity loans typically run from 5-15 years. Also, it must be paid back fully in case the home is sold.
The closing costs for fixed-rate home equity loans are typically similar to the closing costs on a mortgage. When you are shopping around for fixed-rate equity loans, make sure that you ask about the lender’s closing costs and all other third-party costs associated with the loan.
Home equity line of credit (HELOC)
Home equity line of credit or HELOC gives you the ability to borrow up to a certain amount over a 10-year period. Like a credit card, you can simply pay off the interest every month or pay down the principal as well, depending on your financial needs at the time.
A HELOC is a revolving debt which means that you pay down the loan balance and then borrow it again during the draw period. Unlike the fixed rate equity loans, the interest rate for HELOC loans will fluctuate with the changing market rates. In addition, monthly payments will also vary depending on the amount borrowed and the current interest rate.
How Does Home Equity Work?
To put simply, home equity works pretty much the same way as your first mortgage loan. The money from the loan is made available to you in a lump sum, allowing you to use it as you see fit. After you receive it, you start making monthly payments in order to pay it back.
With each monthly payment, you will be paying down a portion of the principal and the interest on your loan.
Qualifying for a Home Equity Loan
Before you start shopping around for lenders for your home equity loan, examine your credit score. To obtain a home equity loan, you’ll need a credit score of 620 or more. The higher your home equity is, the better are your chances to get approved for the loan. If you can’t meet the bar as far as your credit score is concerned, you probably won’t be able to qualify for either type of loan until you improve your credit score.
You must also make your lender believe that you are able to repay the loan. You can do this by providing your credit history and documentation of your household income, expenses and debts, and any other amounts you’re obliged to pay.
Your property’s loan-to-value (LTV) ratio is another factor that lenders look at when determining whether you qualify for a fixed-rate home equity loan or HELOC. So, make sure that you make a strong case by working on all the above mentioned factors before you apply for a home equity loan.
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