Understanding Home Equity and How to Use It
You’ve heard the term, but what is home equity, exactly, and how is it calculated? Investopedia defines home equity as “the value of a homeowner’s interest in their home.” This number changes over time due to both market shifts like local and national trends, as well as your own mortgage payments; the more you’ve put toward your home, the more equity you’ll have.
Why Is Home Equity Important?
Building equity in your home is important for a few reasons. First, it counts toward your net worth because unlike nearly every other asset you buy with a loan, your home can still grow in value after you pay it off. You can also borrow your equity to handle life expenses like home renovations, a down payment on a second home, or to fund education — more on this later. Finally, when it comes time to sell your home, the more equity you’ve built up, the more profit you could make on the home. Equity does take time to build, however, so it should be part of a long-term wealth strategy rather than a short-term plan to get cash.
How Do I Calculate My Home Equity?
Fortunately, you don’t need a fancy home equity calculator to figure out how much equity is in your home: simply subtract your total mortgage balance from the current appraised value of your home.
How to calculate your home equity:
If you’ve been in your home for a while and aren’t quite sure of the current appraised value, there are a few different ways to go about determining it, short of scheduling a formal appraisal. You can start by looking at nearby “comps,” or comparable homes in your area that have similar square footage, number of bedrooms and bathrooms, and floor plans.
You can also look at the cost-per-square foot of your home and find an average. This is also pretty easy to do: simply divide the selling price of your home by the total square footage.
Once you have a general idea of your home’s current value, you can subtract your mortgage balance to find your current total home equity.
Learn how much equity you might be able to get from your home, debt-free, with our home equity investment calculator.
If you’re curious about the rate at which your home might change in value over time, a home appreciation calculator can help.
How Can I Access My Home Equity?
There are several paths to tapping into your home equity, and each comes with pros and cons. Here are some of the most common ones:
- Home equity loan: A loan that offers a predictable monthly payment, fixed rate, and a lump sum payment.
- Home equity line of credit (HELOC): A revolving line of credit that gives you access to cash through a portion of the equity you’ve built in your home.
- Cash-out refinance: A mortgage that replaces your existing one and exceeds your loan balance, providing the difference in cash.
- Reverse mortgage: A loan for homeowners 62+ in which the lender pays you in exchange for your equity.
There’s also a fairly new option called a home equity investment. This loan alternative gives you near-immediate funds in exchange for a share of your home’s future value without having to sell your home or take on more debt.
See how a Hometap Investment works below:
How Can I Use My Home Equity?
While there are many ways to use your home equity — and a home equity investment lets you use it for anything you’d like — it can pay off in the long run to be thoughtful and strategic about where you decide to put the funds you receive. For example, using the money to make home improvements that will potentially add more value to your home is probably a wiser decision than spending all of it on a lavish vacation or a shopping spree. Here are some possibilities to consider:
Pay Off Debt
Paying down debt, including credit cards and student loans, is one of the biggest reasons why homeowners access their equity. And with a home equity investment, this can be even easier to do, since there aren’t any monthly payments to deal with.
Renovate Your Home
Another common use for equity is home improvement and renovation projects. The benefits of this are a few fold: first, you’ll have the satisfaction and enjoyment of that dream kitchen or pretty patio. As we mentioned above, it’s also possible that the renovation will allow you to receive more money for your home if you decide to sell down the road.
Buy a Second Home
Have you always dreamed about a vacation home? How about an investment property that brings in additional income? You can put your equity toward a down payment on a second property. Besides having a go-to getaway spot, you’ll be diversifying your portfolio with real estate as well.
Fund Your Business
Many homeowners use their home equity to start or grow their small business without the hassles of a loan (and the hurdles that come along with getting approved for one).
Live Comfortably in Retirement
If you’re looking for a way to fund current — or future — expenses that your retirement savings can’t cover, like health care, your home equity can save the day and give you peace of mind, along with some extra cash. This is especially attractive if you plan to sell the home within the next 10 years. Though it isn’t required to sell, it may be beneficial to use the proceeds from the sale of the home to settle the Investment.
Fund an Education
With college tuition increasing every year, it can be a smart move to tap into your equity to help pay for your child’s education or start to chip away at that student loan debt.
Diversify Your Portfolio
Many homeowners use home equity investments to balance out their portfolio. A well-rounded portfolio includes a variety of investments that span across at least a few different sectors, including stocks, bonds, mutual funds, and real estate. By distributing your assets, you decrease the risk of a major loss in any one particular area.
Fund Your Growing Family
Whether it’s your first or fourth child, it’s no secret that the costs of expanding your family can add up quickly. Your home equity can cover the costs of childbirth, IVF, adoption, surrogacy, or raising a child.
Get Emergency Funding
Life is full of unexpected events. Whether you need cash, fast, to pay for medical bills, or deal with other surprise costs that pop up, your home equity can get you money in a pinch.
These are just some ideas for how you can use your equity to live a less stressful life — and a home equity investment can help you do it without taking on debt, worrying about monthly payments or interest, or having to sell your home.
Take our five-minute quiz and see if a Hometap Investment might work for you.
YOU SHOULD KNOW…
We do our best to make sure that the information in this post is as accurate as possible as of the date it is published, but things change quickly sometimes. Hometap does not endorse or monitor any linked websites. Individual situations differ, so consult your own finance, tax or legal professional to determine what makes sense for you.
Hometap is made up of a collaborative team of underwriters, investment managers, financial analysts, and—most importantly—homeowners—in the home financing field that understand the challenges that come with owning a home.