# What is home equity?

The house capital or home equity (in English) corresponds to the Owner’s equity interest in a home. This equity can increase over time if the value of the property increases or the balance of the mortgage loan is paid off.

To put it another way, home equity is the portion of property that you actually “own”. If you borrowed money to buy a home, your lender has a claim on the property until you pay off the loan in full, even though you are considered the owner of the home.

Home equity is typically a person’s most valuable asset. That asset can be used later in life, so it’s important to understand how it works and how to use it wisely.

## home equity example

The easiest way to understand your Home Equity is to start with the current value of your home and subtract the amount you owe on any mortgages or other liens.

Let’s say you bought a house for \$200,000, made a 20% down payment, and took out a loan to cover the remaining \$160,000. In this example, your equity in the home is 20% of the property’s value: The property is worth \$200,000 and you contributed \$40,000 – or 20% of the purchase price. Even though you are considered the owner of the property, you officially only “own” \$40,000.

Your lender does not own any part of the property. Technically, you own everything, but the house is being used as collateral for your loan. Your lender secures their portion by obtaining a lien on the property.

Now suppose the value of your house doubles. If it’s worth \$400,000 and you still owe \$160,000, you’ll have a 60% equity interest. You can calculate this by dividing the loan balance by the market value and subtracting the result from one (Google, or any spreadsheet, will calculate this if you use 1 – (160,000/400,000), and then convert the decimal to a percentage). The loan balance remains the same, but the equity in the home increases.

## Build home equity

As you can see, building more home equity is a benefit to you. Here is how to increase your wealth:

### loan payment

As you pay off the loan balance, your principal increases. Most home loans are standard amortizing loans with equal monthly payments that go toward both your interest and your principal. Over time, the amount that goes toward amortization of principal increases, so the accumulated principal increases each year.

If you happen to have an interest-only mortgage or another type of non-amortizing loan, you don’t build equity in the same way. You may have to make additional payments to reduce debt and increase principal.

### price appreciation

You can also build Capital without any effort on your part. When your home increases in value (due to improvement projects or a rising real estate market), your wealth grows.

## Use of home equity

Capital is an asset, so it makes up a portion of your total net worth. You can withdraw some or all of your estate at any time if you need to, or you can pass the entire estate on to your heirs. There are several ways to put that asset to work.

You probably won’t live in the same house forever. Remember that when you move, you can put the proceeds from the sale of your current home toward the purchase of your next home. If you still owe money on a mortgage, you will not be able to use all the money from the sale, you will only be able to use the capital or home equity.

### Borrow against principal

You can also get money and use it to finance almost anything with a home equity loan (also known as a second mortgage). However, it is wise to use that money in a long-term investment for your future. That’s why it would be risky to pay your current expenses with a home equity loan.

### Fund Retirement

You can also choose to spend the capital accumulated in your golden years through a reverse mortgage. These loans provide income to retirees and do not require monthly payments. The loan is considered paid when the owner leaves the house. But nevertheless, these loans are complicated and can create problems for owners and heirs.

## Two Types of Home Equity Loans

Home equity loans are tempting because they give you access to a large amount of money, often at fairly low interest rates. It is also relatively easy to qualify for them since the loans are secured by real estate. Before you take home equity funds, take a close look at how these loans work to fully understand the potential benefits and risks.

### Home Equity Loan

A home equity loan is a lump sum loan. You receive all the money at once and pay it in fixed monthly installments throughout the life of the loan, generally from five to fifteen years. You will have to pay interest on the full amount, but this type of loan can be a good option when a large one-time outlay of cash is required.

Examples of this are: paying for a complete rehabilitation of your house; consolidate higher-interest debt, such as credit cards and personal loans; or buy a vacation getaway. Your interest rate is also usually fixed, so there won’t be any surprise hikes later on, but keep in mind that you’ll likely have to pay closing costs and loan fees.

### Home Equity Line of Credit (HELOC)

A HELOC (Home Equity Line of Credit) it allows you to withdraw funds as needed, and you only pay interest on the loan amount. Similar to a credit card, you can withdraw as much as you need during the “withdrawal period” (as long as your credit line remains open). For this reason, HELOCs are often useful for expenses that may be spread out over a period of years, such as minor home renovations, college tuition payments, and assistance to family members who may be temporarily down on their luck.

During the collection period, you have to make modest payments on your debt. After a certain number of years (10 years, for example), the collection period ends, and you enter a repayment period where you will have to pay off all debt more aggressively, possibly including a hefty balloon payment at the end. .

HELOCs also typically have a variable rate, which means you could end up having to pay back much more than you budgeted for over the 15-20 year life of the loan. The good news is that depending on how you use your home equity loan money, the interest could be tax deductible.

The biggest problem with either type of home equity loan is that your home serves as collateral for the loan.. If you can’t pay for whatever reason, your lender can take your home into foreclosure and sell the property to recoup their investment. This means that you and your family will need to find another home, probably at an inopportune time. To the above we must add that it could happen that the house is not sold for a high price.

For this reason, it’s wise to avoid the temptation to squander your home price gains on exotic vacations, designer clothes, big-screen TVs, luxury cars, or anything else that doesn’t add value to your home. . A safer move is to save cash for those gifts, or even spread the cost using a credit card with a 0% APR offer.

## How to qualify for the loan

Before you start looking for lenders and loan terms, check your credit score. To get a home loan, you’ll need a credit score of at least 680.

The higher your rating, the better. If you can’t meet the requirements when it comes to your credit score, you probably won’t be able to qualify for any type of loan until you improve your credit score.

You must also prove to the lender your ability to repay the loan. This means providing your credit history and documentation of your household income, expenses, debts, and any other obligations you are required to pay.

The relationship loan-to-value or LTV (Loan to Value) of your property is another factor lenders take into account when determining if you qualify for a home equity loan or HELOC. It’s probably best to keep at least 20% Equity in your property, which translates to a minimum LTV of 80%, although some lenders allow larger loans.