The Dynamics of Home Equity

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Real Estate

For many people, their home is their largest asset and, in many cases, their best performing investment. The equity in a home is the difference between what it is worth (i.e. it’s present market value) and what is owed on the mortgage loan. When discussing equity, there are 2 dynamics that work in concert to make homeowner's equity grow; 1) appreciation and 2) unpaid balance.

While it can be said that you “appreciate” the fact that your home is your best financial investment, ironically that appreciation (i.e. the increase in value) is what causes it to be your best financial investment.

In a one-year period, the increase in value divided by the beginning value will determine the rate of appreciation for the year. For example, (current market value minus original investment) divided by (original investment).News stories and articles frequently report statistics on appreciation for the month, the year, or longer. In many cases, a national appreciation is discussed but the local appreciation is more reflective of, and relevant to, an individual property (e.g. your home).

The National Association of REALTORS® reports "The median existing-home price for all housing types in June was $363,300, up 23.4% from June 2020 ($294,400), as every region recorded price jumps. This marks 112 straight months of year-over-year gains."

The low inventory being experienced nationwide has caused some significant appreciation that has increased homeowners' equity. According to Black Knight, a mortgage technology and research firm, at the end of 2020, roughly 46 million homeowners held a total of $7.3 trillion in equity.

As long as a homeowner keeps up with regular mortgage payments the amount of the unpaid balance is declining. For a new loan, a large portion of the homeowner’s payment goes to interest. Over time an increasing portion of each payment is applied to the principal balance to retire the debt based on the term of the loan. One strategy for increasing equity early on is to make over-payments. That is, paying more than the minimum required each month. This applies more money to the principal and as that principal balance decreases, more of the homeowner’s payment applies to the principal. This not only increases equity but also decreases the total amount paid over the life of the loan.

Each month the equity in the home becomes larger because the home is worth more due to appreciation and the unpaid balance is less due to amortization.

Once a homeowner has sufficient equity in their home, they can borrow against it and take cash out of their home. Most lenders require that the homeowner maintain at least 20% equity position. This means that owners can borrow up to 80% of the appraised value less the amount that is currently owed on the property.

The options include a cash-out refinance mortgage or a home equity line of credit, HELOC. While some institutions have stopped offering HELOCs, they are still available.

The HELOC is a line of credit that is established for usually ten years. The owner is approved, and the money is available to draw out as needed. The interest is calculated daily. Like a credit card, when the balance is paid down, the unused portion of the available credit is available again.

Your real estate agent may be able to offer some lender suggestions.