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Equity

DEFINITION

The value of a property, minus the total debt on the property is the equity. Property values change constantly due to payments being made, which is why equity is always changing as well. Basically, the definition equity in regarding real estate is the difference in the amount owed on the mortgage and the property’s fair market value. So to determine real estate equity you need to deduct the value of the mortgage from the property’s fair market value. This may seem fairly simple when you get the hang of it, but that is the point, equity is not all that complicated, it just needs to be fully understood. Otherwise, you can wind up making a bad decision using your home equity and pay a heavy price in return for your decision.

EXPLANATION

Your equity grows as you make payments on your mortgage, which improves the real estate values as well as improves the property itself. However, a decrease with market value and re-mortgaging the property or raising the loan principal amount, and even damage to the property lowers the equity of a property.

A different way to understand equity is that it is the percentage of real property, or the part of the home that you have collected interest in. Technically speaking, you may be a homeowner, but it is likely that you don’t actually own the property fully. Most people cannot purchase a home without first borrowing money in order to do so. This means that you and the lenders have an interest in the property, at least until the loan is satisfied, at which point it becomes the full interest of the property owner.

So the more that you put down for your property’s down payment, the more the initial equity you will have on your new property. So it is actually better if you can afford to make a larger down payment as it will increase the amount of equity you own and will also lower the total amount you will owe. It also helps you to be able to finance additional properties in the future as the more equity you own, the better your chances are that lenders will offer more.

Example of Home Equity

To understand home equity think about when you purchased your home. Let’s say it cost $150,000, at the time of purchase; you put 15% down for a down payment. To pay the remaining amount, you would have received a loan from a lender. What this means is that you have 15% in equity for your home’s value from the start of your buying the home.

So that would mean you take the worth of the home, which in this case would be $150,000 then subtract the down payment, which is 15% of the total, or $22,500. This is how much you technically own of your home.

You can also think of how much is owed rather than how much is paid off when considering equity.

While you repay the loan for your mortgage, you build equity in your home. For every monthly payment that you make, you pay a small portion of your loan balance, or principal, as well as the interest, The lower that the balance becomes, the higher that your equity will grow to be. The equity also grows as the value of the home is raised for any reason.

Purposes For Home Equity

Your personal net worth includes your equity, as it is considered to be an asset. Which means that you are able to use it whenever you feel you need to for any purpose. A popular way that home equity is often utilized is to buy a home, new vehicle, college expenses for a child or yourself, a vacation, or using it to fulfil a dream wedding for you or your children. Be sure to be smart about how you choose to spend this money, if you do so, as it is an important asset for you.

A second mortgage, which is also known as a home equity loan, is not just money that you can use freely. It is vital that you remember that this money, while it may be easy to access, there is an important price to be paid if you do not make your payments on the loan. Your home is offered as collateral for this loan, and if you miss or stop making payments, you may find yourself foreclosing on your home!

For a homeowner, their home brings them a sense of pride. It is important that as a homeowner, you act responsibly and are extremely careful when it comes to your home equity. It is vital that you ask plenty of questions and are aware of exactly what your home equity is before you consider leveraging it for any purpose, such as a loan.

Understanding the fundamentals when it comes to real estate equity is really important. It can be a little confusing and overwhelming if you do not fully understand what you are doing or what a specific term means.

Explaining How Equity is Built For a Real Estate Investment

First, equity is not a solid amount. It is an amount that changes, increasing and decreasing based on the amount of money that is placed into the property. Building up equity will require you to do one of two things.

The first of which is to repay your mortgage. The more mortgage you pay, the more equity you build in your property. This includes making insurance payments as well as tax payments for the property. What this means is as long as you make all you mortgage payments you will continue to build equity in your home.

The second option is to pay more than what you owe of your mortgage principal. This is another great way to build up a home’s equity, being a property that you have invested in. Say your mortgage principal is $500 monthly, but instead of $500, you pay $600 every month because your finances are in a place that you can afford this. When you do this, it allows for you to pay back the mortgage quicker and also will help you to build the equity for your home.

You can actually do both of these things as with the second option, you already are. Since you are making the payments, but adding more to the payment. As long as you are consistent, you will build equity in your home in no time. The second option is obviously the better choice of the two as it speeds up the timeline for you to fully own your home, which means you would have 100% of your home’s equity faster.

How Improvements to a Property Affect Your Home’s Equity

Any time that you make improvements that benefit your property, you are increasing the equity in the home. This is due to the fact that renovations and improvements for a property create a forced appreciation for the fair market value of the home. That increase then goes into your credit; the lender does not get the credit seeing as you are the official owner. The only real way to know just how much equity you have built is found out when you choose to sell the home, or you can have it appraised.

Property Appreciation & Equity

Real estate properties often appreciate in their value annually. This is a good thing as it will increase your equity when your property appreciates. So the higher appreciation your property has, the higher your equity will be.

Let’s say you buy a property that was worth $250,000, and you make a down payment of $100,000. The rest, which is $150,000 is covered with your loan. So a few years down the road, you decide you want to sell, and the property worth has increased from $250,000 to $300,000.  This would mean your equity is $150,000, not including what you have paid in mortgage payments over the years you lived on the property. If you made $30,000 in payments over that time, your equity would be $100,000 (your down payment) plus $50,000 (your property’s appreciation) plus $30,000 (your mortgage payments), which equals a total of $180,000. This is not including any improvements made to the house as that is also a factor in your home’s equity. That is why it is difficult to determine your home’s exact equity without deciding to sell or hiring a professional to have the home appraised.

How A Property’s Equity Is Able To Decrease

Just as there are ways to increase the amount of equity that is in your home, there are also factors that will cause a decrease in your home’s equity. Below are four ways that will factor into a decreased equity for your home.

The first way you can cause a decline in your home’s equity is getting a home equity loan, also known as refinancing your mortgage. This is due to the fact that when you refinance your home, you are using your home’s equity as collateral for the loan. This can be a great way to buy a investment property if you do not have a lot of money on hand.

Another decrease in home equity comes from a fall in the real estate market. When real estate values fall, home equity falls right alongside it. This happened from 2006 to 2011 in almost every part of the country. Equity can also fall due to homes selling for lower in your area, especially if you are close to or are underwater on your current mortgage. Say you make a $50,000 down payment on a home that you just purchased, but then the real estate market value drops over $65,000. This means that you no longer have equity in your home. If you sold that same home at that time of the drop, you would owe the lender $15,000 to make up the difference in the cost.

Increasing the principal loans on your home is another way that you can decrease the amount of equity you have in your home. Taking out a second mortgage, or even a first as we mentioned above, will likely lower your home equity.

A home that is destroyed, burned down, or in a disaster situation and there is not enough insurance available to cover it; you lost both the home and the equity. That is also why it is so important to keep up with repairs and problems with the house as they also affect the equity of the home as your home deteriorates or stops functioning properly.

How Damages & Maintenance Affect Equity of a Home

Our last paragraph leads us to understanding how damages affect the property, and ultimately how that affects your equity of your home. Damages to a property or home need to be fixed as soon as possible as they will affect your share of equity in the home if you do not have a policy with your insurance that covers the damage. This is important to remember as the upkeep of a home is vital to getting the best price when selling a home or if you are looking to get the most equity out of your home as possible.

Neglecting the home or property is definitely a bad idea as it is against your best interest for the property. When you keep repairs, maintenance, ect., for a home, then you build and increase the equity as well. That makes your home or property value increase in worth so that you obtain the most equity possible when you keep a home or property in excellent shape.

Why Equity Really Does Matter To A Homeowner

In real estate, equity is vital. It means that more of your property belongs to you, the owner and it has a value. Which is why everyone wants to have some sort of equity available. When you do not have equity, it makes it vastly more difficult to sell a home, or borrow against a home as there is more owed to the lender than what is actually owned by you. This is what the purpose of a down payment, which is required when a home is bought, is for, as it will protect the lender from any loss in an event such as a foreclosure.

The equity is basically a buffer for if a homeowner chooses or winds up defaulting on payments as it makes a mortgage a good investment for a bank. When a property has one hundred percent of it’s equity, then it has the complete value of the home available to the person who owns the home. It also means that the property has been paid for in full.

Final Thoughts

Home equity can only be determined in one of two ways, the end of a sale or through appraisal. If you can get a better price for the sale of your home you increase the equity of the home. If you do not pay for buyer’s repairs they request or give the buyer a credit for the cost of closing, your equity will increase in this way as well.

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