What is home equity?
Home equity is the portion of your home you own outright: your stake in the property as opposed to the lender’s. It equals the percentage of your home you originally paid for in cash (via your down payment) and have since paid off (in your monthly mortgage repayments). In mathematical terms, home equity is the appraised value of your home minus any outstanding mortgage and loan balances. As long as your home doesn’t depreciate in value and you continue to make on-time payments, equity will naturally build over time.
How to calculate home equity
To calculate the equity in your home, follow these steps:
- Get your home’s estimated current market value. What you paid for your home a few years ago or even last year might not be its value today. You can use online home price estimator tools, but consider talking to a local real estate agent or licensed appraiser to get a more accurate measurement of your home’s market value.
- Subtract your mortgage balance. Once you know the market value of your home, check your latest mortgage statement. Subtract the amount you still owe on your mortgage and any other debts secured by your home. The result is your home equity.
How to Leverage Your Home Equity, what are your options?
Home equity refers to the difference between the market value of your home and the outstanding mortgage balance. To leverage your home equity, you will need to access the equity in your property, which is similar to obtaining a mortgage. Typically, you can borrow up to 80% of your home’s value. One popular option to access your home’s equity is through a home equity line of credit (HELOC), which provides instant access to fund. It’s essential to explore all financing options for rental properties and consider all-in-one mortgages.
These mortgages combine a regular mortgage component with a line of credit, allowing you to utilize the line of credit to buy rental property and convert the owing balance to a fixed term. Working with a mortgage broker can help you review multiple scenarios and choose the best financing option for your needs.
1. Home Equity Loan:
A home equity loan is a lump-sum loan that allows you to borrow a specific amount of money using your home’s equity as collateral. The loan is paid back in fixed monthly installments, typically over a period of 5-30 years.
2. Home Equity Line of Credit (HELOC):
A HELOC is a revolving line of credit that allows you to access your home’s equity as needed, up to a predetermined limit. This option provides flexibility, as you can draw funds when required and only pay interest on the borrowed amount. HELOCs typically have a variable interest rate and a draw period, followed by a repayment period.
3. Cash-Out Refinance:
A cash-out refinance involves replacing your current mortgage with a new one for a higher amount. The difference between the old and new mortgage balances is paid to you as a lump sum. This option allows you to tap into your home equity while potentially securing a lower interest rate or better mortgage terms.
4. Second Mortgage:
A second mortgage is a separate loan taken out in addition to your existing mortgage. This option allows you to borrow against your home equity while maintaining your current mortgage. However, second mortgages usually come with higher interest rates compared to first mortgages.
The takeaway
If you’re considering a investment property purchase, a home equity loan is one financing option to explore. But remember: They do come with risks—particularly if you’re borrowing against the equity in the home where you live.
Before you apply for one, do the math. Make sure you have the funds to comfortably cover your payments—both on your main mortgage and the home equity loan—not just today but over the long haul, too.
“A home equity loan is a type of secured loan, which means that if you default on the loan, your lender could foreclose on your home,” Shekhtman says. “It’s important to make sure that you can comfortably make the monthly payments before taking one out.”
