What makes owning a home such a smart financial decision? As you pay off your mortgage loan – or as your home increases in value – you build up equity. You can then tap into this equity to help fund home repairs, pay a child’s tuition or invest in another piece of real estate.
What is equity?
Here’s how equity works: Say you take out a mortgage of $190,000 to buy a home with a sales price of $200,000. Say, after seven years, you’ve paid off an additional $70,000 from your mortgage. If your home is still worth $200,000, you now have $80,000 worth of equity: With your $10,000 down payment included, you now owe $120,000 on a home valued at $200,000.
But say your home has increased in value since you bought it and is now $220,000. Now, your equity would be $100,000: You owe $120,000 on a home worth $220,000.
Tapping into equity
Once you have equity, you can take out either a home equity line of credit or home equity loan. These are two very different things. A home equity line of credit – also known as a HELOC – is like a credit card. If you have $100,000 worth of equity, your lender might approve you for a line of credit of $70,000. This is like a credit card’s credit limit. You can borrow up to $70,000. But if you borrow only $40,000, you only need to pay back that amount, plus interest.
A home equity loan is a traditional mortgage loan. If you have $100,000 worth of equity, your lender might approve you for a home equity loan of $70,000. You’ll then receive that money as a lump sum payment. You’ll pay it back with regular monthly payments, plus interest, just like you would with a primary mortgage loan.
So, what should you do with your home equity? You can do just about anything. Say your son is accepted into an expensive college. You can take out a home equity loan to help pay his tuition. Maybe you want to add a master bedroom/bathroom addition to your home. You can take out a home equity line of credit and borrow enough to cover the renovations.
You can even use your equity to cover the down payment and closing costs on an income property that will provide you with rental income every month.
The key is to study your own financial needs and goals. You can then use your home equity to fund your dreams.