How Does Equity Work?

What is Equity

The equity in your property is the appraised value minus the payoff amount of your mortgage or mortgages. When a buyer buys a home, there is an appraisal done on that home to find the value. The value is not always equal to the sales price. The home could be selling for more or less than the market value, so you can't use the sales price in every case to find equity. If the property is appraised at $200,000 and the payoff of the mortgage is $150,000, the equity is $50,000. Sellers must remember when selling a home that the closing costs are paid out of that equity. So the proceeds from the sale would be less than the actual equity.

What Equity is Used For

The equity in a home can be used for many things. Home equity loans and lines of credit are options. With a home equity line of credit (HELOC), you pay an application fee and some closing costs. However, you don't pay interest on the money until you use it. With this type of loan, you can use all of it at once or small amounts at a time. You will only pay interest on the amount you use, not the available balance. These loans are great to have if you are very disciplined and would only use them in an emergency or for a project that you can fit into your budget. A home equity loan is commonly used for big projects like putting an addition onto the house. Both of these loans are mortgages. They will become a lien against the property. A HELOC is a good loan to use to make investments, because the interest rate is usually lower than credit cards and other unsecured loans. Sometimes a HELOC has a better rate than that of a car or boat. A buyer must check the fees charged for both loan types to know which is the better choice. Both of these equity loans are used quite often for debt consolidation to pay off high-interest credit card and loans. This works well if the borrower does not go right back to using the credit cards and can afford the payments. If borrowers miss payments on an equity loan, their home can be subject to foreclosure.

How Equity is Built

The equity in a home will automatically increase as property values go up. Equity can be lost if property values go down, but that is normally a short-term adjustment before they start going up again. A property owner can also build equity faster by making extra principal payments on the property every month. Many lenders have a special box on the payment record for the extra principal payments. Other lenders have set up programs in which the property owner can make payments every two weeks instead of once a month. This allows for an extra full payment against the principal every year. Building the equity in the property gives owners choices and opportunities they may not have otherwise.