Home Equity Basics Explained

What is Home Equity?

Purchasing a home is a huge event in anyone's life. It's an investment that, over time, will yield you a significant profit. As the years progress, the value of your home will increase. When the time comes to sell, you'll find that in most cases you'll be able to get significantly more for your home than what you originally paid for it; yielding you a profit on your original investment.

But the resale value of your home is not the only value your home contains. When you purchase a home and make payments on your home mortgage, you start building what is called home equity. Home equity is the difference between the current resale value of a home and the amount still owed on the mortgage. As the principal of the mortgage amount decreases as a result of monthly mortgage payments, the home equity increases.

What is the Value of Home Equity?

Home equity is money in the bank. Home owners can borrow against their home's equity to pay for home repairs and renovations, school tuition, costly medical expenses, and even pay off debt. Your home provides you with financial opportunities not many lenders can provide. Home equity is a significant advantage to purchasing a home and a great financial resource to have. You never know what life will throw at you. It's always good to have a readily available resource to turn to when you're faced with a financial crisis.

How do I use My Home Equity?

If you want to use your home's equity for home repairs, college tuition, etc., you first need to get a home equity loan. A home equity loan is a loan based on your home equity. There are two types of home equity loans: 1) a second mortgage (a.k.a. traditional home equity loan); and 2) a home equity line of credit loan. A second mortgage is a loan where the lender lends you a lump sum, based on your home's equity, and interest starts accumulating once the loan is issued. A home equity line of credit loan, however, is a loan where the lender presents you with a credit card or checkbook that you can use to make purchases. Just like a second mortgage, the amount you can spend is based on your home's equity. But unlike a second mortgage, interest on a home equity line of credit loan doesn't start accumulating until you make your first purchase with the card/checkbook.

Both home equity loan types are feasible means to utilizing your home's equity. Which type of loan you choose is up to you and your specific financial needs. Both loan types are primarily low interest loans and, for most home equity loans, the interest you pay is tax deductible.

However, it is important to know that when you take out a home equity loan, it means the lender can reposes your home if you default on your payments. In other words, if you don't pay your home equity loan in full or default on too many payment, the bank or lender can take away your home and use its current value to pay for what's owed. So it's crucial that you maintain your loan payments. A home equity loan is a great financial resource, but if you don't pay it back, it could end up costing you your home.

Purchasing a home is a venture worth taking. The appreciation of your home's value and the equity you can build make your home a profitable investment that can't easily be matched.