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Do You Really Understand Your Home's Equity?

Written by Jaymi Naciri on Wednesday, 30 April 2014 12:38 pm
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As a homeowner, you probably think you know all about what your home is worth, what your interest rate really means, what you are paying out every month, and how to access your equity if you needed to.

But do you really? If your home is worth $20,000 more today that it was when you purchased it, does that mean you are entitled to all 20,000 of those dollars? Does having equity in your home automatically mean you can sell for a profit? Would you know what your best option was if you needed some equity in a pinch? Check out the scenarios below for a quick equity tune-up.

Scenario One

Your neighbors just sold their home for a pretty decent amount. That must mean your house is worth at least as much as theirs. I mean, your kitchen hasn't been redone like theirs, but your exterior is prettier, so that's probably a wash. Score! Honey, call the bank and get us some cash. We're going on vacation!

Realty Check

Not so fast. Your neighbor's home sale might give you an idea of what your house is worth, but there's a lot more to it. Your home's age and condition, the square footage, the location on the street—all of this factors in to determining your sales price. And don't forget to add in closing costs and Realtor fees and the price of moving. You also have to take into account your credit and payment history. Straight equity is only one part of a more complicated equation. Before you book that African safari, you might want to check your credit and talk to your lender.

And, by the way, your "prettier" exterior will probably not wipe away the memory of your ugly kitchen if you do go to sell. The old adage about kitchens and bathrooms selling home: still true.

Scenario Two

You've been living in your house and paying the mortgage for 15 years without refinancing. You must be sitting on a goldmine! Time for a cash-out refinance. First you'll pay off your credit card bills and then you'll buy all-new living room furniture. Then there's this yacht you've had your eye on…

Reality Check

A cash-out refinance, which allows you to "refinance your mortgage for more than you currently owe, then pocket the difference," said Bankrate, can be a great option, depending on your financial condition and what you plan to do with the money. "Remember the Mother Goose rhyme about the old woman who lived in a shoe? That is so 18th century. Today, she would live in a piggy bank, and so would her neighbors. Homeowners today treat their houses like piggy banks, readily transforming their equity into cash and credit."

Different from a home equity loan, a cash-out refinance replaces your existing first mortgage. You may have lower rates than with a home equity loan but you pay closing costs, just like you would on any refinance, and you'll have to pay private mortgage insurance "if you end up borrowing more than 80 percent of your home's value." If your interest rate is much higher than going rates and you know you have a good amount of equity, it might make sense to go for it. But if you have terrible credit, your rate might not get much better. And, you'll have to determine whether refinancing and going back to square one with a mortgage is worth it.

"If you're going to make payments for 15 or 30 years, it makes sense to spend the money on something enduring: an addition to the house that will increase its value, potentially lifesaving experimental medical treatment that your health insurance won't pay for or to start a business," said Bankrate. "Do you want to spend 15 years paying for your month-long dream vacation? Do you want to spend 30 years paying for that Porsche? The car might be on the junk heap by the time it's paid for."

Scenario Three

It's hot outside. And it's hot in the real estate market. It's time to take advantage of both and build that pool you've always wanted. You'll just get a home equity loan or a line of credit. What's another couple bucks a month?

Reality Check

A home equity loan is a separate loan on top of your first mortgage that's paid out in a lump-sum and is paid back in fixed monthly installments. An equity line of credit is a specific amount you can borrow against your home. Both will require you to have sufficient equity in the home, which will be determined by the bank.

The home equity loan is a fixed rate, while a home equity line of credit "typically fluctuates with the prime rate," said US News. "Remember that with a home equity loan, you are paying interest on the entire amount of the loan, whether or not you are using the proceeds. With a home equity line of credit, you only pay interest on the amount you borrow."

The loan usually has higher rates than a cash-out refinance, but interest is a tax write off and may be a good option for someone whose "current mortgage is at a lower interest rate than you could get now by refinancing," said Bankrate.

And if the money loaned is being used to improve the home and not improve your wardrobe, your passport stamps, and your close personal knowledge of caviars of the world, all the better. "The best use for home equity is to buy things that will contribute to your home's value, like a needed remodel, or your family's future income, like a college education," said Houselogic. "Consider carefully before you cash in home equity to spend on consumer goods like clothing, furniture, or vacations.

Scenario Four

You check Zillow and see that houses in your area have appreciated by 20 percent in the past year. You are ROLLIN' IN IT! Time to take that money and go buy a house to flip. You're gonna be a mogul!

Realty Check

Before you quit your job and start researching property auctions in your area, take a beat. In many states, home sales are not reported. That means online real estate sites may be using limited listing info and sometimes even outdated tax records to determine home values. The only way to get a true picture of your home's value is to have an agent prepare a competitive market analysis or hire an appraiser. Armed with this information, you can act on those real estate mogul dreams if you still want, Mr. Trump.

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Individual news stories are based upon the opinions of the writer and does not reflect the opinion of Realty Times.
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