A recent study reported that more than 15.2 million homes in the United States were equity-rich as of June 30, 2021, which is more than 27.5% of all the homes in the US. (Source: ATTOM Data Solutions)
The same study also disclosed that that the San Jose, Santa Clara, Sunnyvale metro ranks #1 in the nation among the top 10 U.S. metros with the highest home seller profits in 2021.
1). What is Home Equity?
Although equity is one of those things that everybody knows about, it is a multifaceted concept. Here are a few tips about how to define and use home equity in the most productive ways to keep building your wealth.
Equity in a property AKA “Home Equity” is usually defined as the difference between the current value of your home and how much you owe on it. For example, if your home is worth $400,000 and you still owe $220,000, your equity is $180,000.
If you are “Equity Rich”, this means that you have at least 50% equity in your property or that the amount you owe on your home is no more than half of your current property's market value.
The most common ways to access the equity in your home are a HELOC, a home equity loan or a cash-out refinance. To tap into your home’s equity through one of these 3 options, you’ll need to go through a process that’s very similar to obtaining a mortgage.
1-1). A Home Equity Line of Credit better known as a HELOC, is more like a credit card, only the credit limit is tied to the equity in your home .If you have $40,000 of equity, you might qualify for a HELOC with a maximum spending limit of $30,000. As with a credit card, you only pay back what you borrow. So, if you only borrow $20,000 on a kitchen renovation, that's all you have to pay back, not the full $30,000.
1-2). A Home Equity Loan works like a second mortgage. Say you have $50,000 in equity and you qualify for a home equity loan of $40,000. Your lender will lend this $40,000 in a single payment and you will pay this loan back in monthly installments, with interest, just as you pay back your primary mortgage loan.
1.3). With a Cash-Out Refinance, you refinance for more than what you owe on your mortgage. Say you owe $180,000 on your mortgage. You can refinance for $220,000 and then take the extra $40,000 in cash. You will repay the $220,000 total in monthly payments, with interest.
To determine the amount of equity in your home your lender will consider multiple factors such as your debt-to-income ratio, your loan-to-value ratio, your credit score and your annual income. Additionally, to determine the amount of equity in a home, your lender will hire an appraiser to determine the current market value of your home. Lenders generally allow homeowners to take out 80% to 85% of the value of a home, minus existing mortgage balances.
2). How to Use Equity to Build Wealth?
Here are the three most common ways to use equity:
2-1). Home Improvements
Home improvement is one of the most common reasons homeowners take out home equity loans or HELOCs. Besides making a home more comfortable, upgrades could raise the home’s value and draw more interest from prospective buyers when you sell it later on.
2-2). Buy a New Home that Better Fits Your Needs
Some homeowners use their equity to power a move into a home that fits better their current needs, either moving into a larger home or downsizing.
Let's say the home you’re selling is worth $220,000, and you've built $70,000 worth of equity in it. If you sell your home, you probably won't get the entire $70,000 in equity because of fees such as mortgage and title closing costs but you’ll end up with a profit that you can then use for a large down payment on your next home.
2-3). Relocate
If the size of your home isn’t a challenge but your current location is, it could be time to relocate to a new area. Maybe you enjoy vacationing in the mountains, at the beach, or another area, and you’re dreaming of living there year-round. Or perhaps the distance between you and your loved ones is greater than you’d like, and you want to close the gap. No matter what, your home equity can fuel your move to the location where you really want to live.
Home Equity is an important financial tool and one of the greatest financial benefits of owning a home. That said, it should not be used to generate more debts. Always keep in mind that if you fail to repay a home equity loan, a cash-out refinance, or a HELOC, you could lose your home to foreclosure.
Also, there’s no guarantee that your home value will increase substantially over time. Your home may even lose value in times of economic downturn. If you take out a home equity loan or HELOC and the value of your home declines, you could end up owing more between the loan and your mortgage than what your home is worth.
Hope this helps.
Sources: realtor magazine daily news, attomdata.com, keepingcurrentmatters.com, quickenloans.com, bankrate.com