Understanding home equity: Everything you need to know
November 11th, 2021 Share
The average homeowner saw a 20% increase in home equity in the first few months of 2021.
Home equity can be used to fund a number of life stages — from buying or building a new home, to retirement, to home improvement projects and beyond.
Borrowers should understand how their home equity is calculated and what the best options are for tapping into it.
You may have seen the headlines earlier this year: Due to fast-rising home prices, the average homeowner gained more than $33,000 in home equity in just the first three months of 2021. That represented a 20% jump in home equity, on average.
But despite these big gains, it’s harder than ever for some homeowners to make ends meet. While everyone’s financial situation is different and we can’t make specific recommendations on whether you should take advantage of your home equity, it’s important that homeowners understand the power and options they have in today’s unique market environment.
Let’s dive into what home equity is, and the choices that homeowners with equity can leverage if desired.
What is home equity?
In the simplest terms, home equity is the difference between what you owe on your mortgage, and your home’s current market value. If you owe $100,000 on your mortgage and your home is worth $400,000, then you have 75% home equity. Conversely, if you have a remaining mortgage balance of $300,000 on your $400,000 house, you have 25% home equity.
Your home’s equity rises when:
This year, the red-hot housing market was a major contributor to homeowners’ gains in home equity: A rapid jump in home sales created higher sales prices, leading to higher home values and a 20% average home equity increase for homeowners.
What happens to my mortgage insurance when my equity rises?
Two groups typically pay mortgage insurance to their lender:
Mortgage insurance payments help lenders offset the risk of lending to less-than-perfect loan candidates, but that risk is diminished when the home’s equity begins to rise. Once the borrower’s home equity reaches 20% of the original purchase price, their mortgage insurance will be canceled for the rest of the loan term.
What can I do with my newly accumulated home equity?
There are a multitude of options available for homeowners who want or need to leverage their home’s equity. Below is a list of the most common paths for using or tapping home equity. Remember, your financial situation is unique and you should speak with your financial advisor and lender to determine your ideal path.
Sell and pocket a profit
The easiest-to-understand way to benefit from your home’s equity is to sell your home and reap the profits. If you owe just $50,000 on your $450,000 house, for example, then nearly $400,000 in home equity will be yours as you leave the closing table. (You’ll have to pay your agent’s commission and closing costs on the property.)
You can use that net profit to fund your next chapter — whether that be a new property, a retirement community, or an RV that will take you across the country in your golden years.
Apply for a reverse mortgage
Homeowners who are 62+ and have most of their wealth tied up in their home may consider a reverse mortgage. In a reverse mortgage, the homeowner stops paying their monthly mortgage payments and their lender gives them a monthly or lump sum based on their home’s equity. As you would expect, this agreement will diminish the homeowner’s equity over time, and increase their debt; the homeowner will then pay off the lender with the profits of their eventual home sale.
Reverse mortgages can be beneficial for homeowners who wish to age in place, but who don’t have the savings or investments to fund their retirement.
Borrowing against your equity
Last, there are three other ways to borrow against your home’s equity. Each of them have different terms and benefits.
Fixed-rate home equity loan: Homeowners can tap into their home equity to cash out a single lump-sum payment. The loan has a set interest rate and a typical payment term of between 5-15 years.
Home equity line of credit (HELOC): Homeowners can tap their home equity as needed, in a revolving line of credit that is akin to a credit card. Borrowers have a “draw” period, when they can take out the money, followed by their repayment period. HELOCs usually have variable interest rates that change over time, though some lenders are beginning to offer fixed-rate HELOCs.
Cash-out refinance: Think of a cash-out refinance as a two-step process. First, borrowers replace their existing mortgage loan with a new loan that exceeds the amount they owe on the home. Next, they receive a lump sum payment that represents the difference between their home’s value and the amount they’ve borrowed.
Whether it’s to consolidate or pay off debt, make home improvements or to fund other needs, these options can be a helpful solution for the right borrower.
Need help calculating your home equity?
Big financial decisions should be made carefully, and you’ll need an experienced team to help guide your way. For help understanding your home’s equity, reach out today for private, professional assistance.
*This information is provided for informational purposes only and does not constitute legal, tax, or financial advice.
Edina Realty Mortgage is an affiliate of Edina Realty. See Affiliated Business Arrangement Disclosure Statement
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