Homeownership is widely regarded as the pinnacle of success. For most individuals, owning a home is a dream come true. It beats renting because you actually have a vested interest in the property. Every monthly mortgage payment gradually chips away at the outstanding balance.
In the first years of homeownership, the lion’s share of mortgage payments goes towards interest on principal. Over time, an increasing share of every payment tilts toward principal paydown, and less toward interest. By the end of a mortgage term, all of the principal is paid off, and the house belongs to the owner 100%. That’s the short and sweet of it.
Broadly speaking, the owner’s share of their property is known as equity. It’s your dollar share, given the market price of the property less the outstanding mortgage.
Reasons Owners Tap Into Home Equity
There are loads of reasons why homeowners want to tap into their home equity. Everyone realizes that a home is a constant work in progress. Nothing is static in a home, besides your property’s address. It’s a self-contained entity. But remember, your home is subject to the elements, wear and tear, and it always needs TLC. It doesn’t take long for neglect to reflect in a home. That’s precisely why regular maintenance, upgrades, or finishing touches are necessary.
Each homeowner is different. Some folks are hands-on with their property. You probably know the type – those homeowners who are constantly tinkering with their to-do lists. Perhaps you’re the type of homeowner who prefers major structural upgrades? Clean energy solutions like solar panels on the roof for heated swimming pools are pretty common nowadays. Speaking of roofs, a new roof is a big investment, especially for hurricane compliance insurance underwriting. Many homeowners in the southeastern United States know all about this. New kitchens, bathroom upgrades, floor tiles instead of carpets – the list goes on and on.
Home equity is your trump card when cash is tight. We live in interesting times where job stability is not a given. Inflationary pressures are a constant bugbear, and disposable incomes feel like they’re shrinking for a lot of people. Homeowners can access home equity in different ways. A traditional homeowner may be able to access up to 80% of their home equity with a good lender, but a veteran can use a VA cash out refi home equity solution to get up to 100% of their home equity. It all depends on the terms and conditions of your particular mortgage.
Understanding Home Equity in Action
Below are three unique examples to illustrate how equity changes over time:
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Scenario A: Property Prices Rise Sharply Relative to What Your Purchase Price
Let’s say you’ve paid $100,000 of your $500,000 mortgage. Let’s also assume that the market price of the property is $650,000. Your equity (share of the property) at today’s market price is $650,000 -$400,000 (what you still owe) = $250,000.
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Scenario B: Moderate Price Appreciation Takes Place
In this next example, let’s assume that you’ve paid $200,000 of your $500,000 mortgage. Maybe the market is a little tepid and the market price of your property is $550,000. Your equity (share of the property) at today’s market price is $550,000 – $300,000 (what you still owe) = $250,000.
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Scenario C: The Dreaded Reversal in Real Estate Prices
This is a very different example. But it can happen when markets sour. Luckily, it’s less common. Let’s say you have paid down $250,000 of your $500,000 mortgage, and the market price of the property is $480,000. Your equity (share of the property) at today’s market price is $480,000 – $250,000 (what you still owe) = $230,000.
Each scenario paints a different picture. For example, in Scenarios A and B, the owner’s equity is positive. Why? Because the value of the property exceeds the remaining mortgage balance. But in Scenario C, the property’s price has fallen below the purchase price. As a result, the owner’s equity is less (still positive) than what they have contributed.
Generally speaking, real estate is considered to be a viable long-term investment for many different reasons. It may not necessarily appreciate in value as much as the stock market on an annualized basis, but it provides a foundation for stability and growth. It’s also an important factor in building communities over the long-term.
Of course, tapping into home equity isn’t something to rush into. Try to bare in mind that it’s still debt; it’s just structured differently. Used wisely, it can solve real problems or unlock value you’ve already built. Used carelessly, it can set you back. Like anything in finance, timing and discipline matter more than anything else.
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