What is home equity?

Home equity is the home loan you have paid off. It is the difference between the market value of the
property and the other liens attached to it. Assume that market value of a home is $100,000. You
paid a down payment of 20%, that is, $20,000 while buying the property. Now you will have to pay
$80,000. Here the home equity is $20,000.
In this article, let us look into the details of what a home equity is, its working, how to calculate it,
drawbacks and also about home equity loans.

Working of home equity

Assume that person A buys a home from a bank. He takes a loan from the bank to buy the house.
The person pays a down payment to buy the home. He then repays the rest, say within 5 years. The
value of the home is $600,000. Person A paid a down payment of $100,000. He is to repay at the
rate of $100,000 per year. So in the beginning, home equity held by A will be $100,000. At the end of
one year, home equity held by A will be $200,000 (assuming interest is 0%). At the end of third year,
the person A would have repaid $300,000. Therefore, at the end of third year, his home equity is

How to build home equity?

Building home equity means you are decreasing the difference between the property value and the
amount you have to repay. Take the previous example. Person A paid $100,000 of down payment to
buy the home. So here the difference is $400,000. If he had paid $200,000 of down payment, then
the difference is $300,000. If the difference decreases, the property value you hold in hand
increases. Here are some tips to build your home equity:

Make a big down payment

Down payment is the initial amount you pay while buying the property. This acts a security. Here in
this example, the down payment is $100,000. If person A pays $300,000 as down payment, then he
needs to repay only $200,000. The home equity he holds is high here. If he pays $400,000 as down
payment, then he has to repay only $100,000. Here, the home equity he holds is even more higher.
So higher the down payment, higher is the home equity.

Repay in short period of time

When you pay in shorter duration, you can save lots of money. This is because the interest you need
to pay decreases. Take the above example and assume that the person A is repaying at an interest
rate of 10% per annum. This means he has to pay $5,000 per year as interest. If he is repaying within
5 years, then he will pay an interest of $25,000. If person repays within 3 years, then he will pay an
interest of $$15,000.

Therefore, shorter the repayment period, lesser is the interest.

Make biweekly payments

In biweekly payments, you repay twice in a month. Instead of monthly repayments, if you opt for bi
weekly payments, you can finish your mortgage quick. If you are repaying as monthly payments,
then you will make 12 payments in the year. In biweekly payments, you will make 26 payments in a
year. This is because, a year has 52 weeks.
If you apply the bi-weekly payment in the above example, person A will repay in two and a half
years. In monthly payment, person A is repaying in 5 years.

What are home equity loans?

These are loans that allow you to borrow against the home equity you own. Take the above
example. The person A will hold $200,000 equity of the home in the end of two years. Now he can
take loan against this $200,000. These loans are home equity loans.

How to calculate home equity?

You calculate the equity by subtracting the amount of loans on the house from its value. Assume
Alex owes $140,000 on mortgage. The current value of the property is $400,000. Therefore, the
home equity is $400,000-$140,000, which is, $260,000.

Drawbacks of home equity

Every coin has two sides. There are some disadvantages in buying home equities. Your home is at
constant risk till you repay the amount completely. You are borrowing a lump sum. You may develop
stress if your budget goes tight.

It is good to go for home equities, when you are financially stable. Fix the repayment amount based
on your income. If you allocate major part of your earnings in repaying, you may develop stress.
Hope my article on home equity was helpful!

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes:

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>