Understanding Home Equity: What California Homeowners Need to Know

The dream of homeownership in America is alive and well, as it provides families with a place to call their own and a way to build wealth over time. Equity is key to this wealth-building, as it comes from the increase in property value over time.

What Is Home Equity?

Your home’s equity is the difference between how much your home is worth and how much you owe on your mortgage. It can be thought of as the portion of your home that you actually “own.” The more equity you have, the more money you have available to use if you need to, such as in a time of financial hardship. Conversely, if your mortgage balance exceeds your home’s value, then you would have negative equity.

Example:

Home Value: $900,000

Down Payment: $180,000

Mortgage: $720,000

Home Equity = $180,000

Why is Building Equity Important?

Building equity in your home can provide you with a number of benefits.

You can borrow from your equity as a loan, invest it, build long-term wealth or sell your home for more than you owe and keep the difference.

When you sell your home, you will likely make a profit. The proceeds from the sale first go toward paying off your mortgage balance, and then you keep the rest of the money. The more equity you have in your home, the more money you will make from the sale. Just remember that you may need to pay a capital gains tax on the money you make from the sale.

You don’t have to sell your home to use your equity. You could borrow against the equity in your home through a home equity loan or line of credit (HELOC). These are second mortgages that let you borrow money from your equity and use your home as collateral. That means if you don’t pay the loan back, you could lose your home. The difference between the two loans is that a home equity loan provides all the money at once while a HELOC lets you borrow money as you need it.

How Do You Build Home Equity?

You will make mortgage payments that will decrease the amount you owe on your loan. This will lower your monthly payments and help you pay off your mortgage sooner.

For the most part, the value of your home will change over time. While it can go up or down, the average yearly appreciation for homes in the US is 3%. If your home is in an area where property values are increasing and you’ve kept up with maintenance, your equity will grow as well.

It’s important to note that home values can rise or fall due to market conditions. However, by making your monthly principal payments and through appreciation, you can build equity in your home, which can help you create financial stability.

Shorter Term Refi

If you pay off your mortgage, you will have 100% equity in your home – as long as you don’t have any other liens on the house. By refinancing to a shorter loan term, you can save thousands of dollars on the interest you would have paid during the longer term.

Keep in mind that when you shorten your loan term, your monthly payments will increase because you will have less time to pay off the loan balance. You may also have to pay closing costs for your new loan, so make sure you are able to afford to refinance to a shorter term before applying.

Do Away with Mortgage Insurance

If you don’t have at least 20% of the purchase price saved up for a down payment on a home, you will need to get mortgage insurance. This protects the lender in case you can’t pay back your loan. The only way to avoid this is to put down at least 20%. Mortgage insurance usually costs between 0.1% and 2% of your loan balance each year, which is added to your monthly mortgage payment. If you can get rid of mortgage insurance, you could apply that extra money you’re currently paying to the principal balance of the loan and build more equity faster.

Mortgage insurance for an FHA loan is known as the mortgage insurance premium (MIP). If you make a down payment of at least 10%, you’ll pay MIP for 11 years. If your down payment is less than 10%, you’ll pay MIP for the life of the loan. So, if want to remove PMI, either refinance your FHA loan into a conventional loan or wait 11 years.

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