The Basics of Home Equity

As a homeowner, the equity in your home is one of the biggest assets you have. This fact may surprise you, especially if you do not understand what exactly home equity is. Thankfully, refinancing can make it simple to see how powerful your home equity can be.

In today’s blog, we will discuss the home equity basics and how cash-out refinancing can help you turn the value of your home into cash. At Local Mortgage, we believe in giving homeowners the assets they need to make smart financial decisions for their future. For that reason, we are happy to explain home equity and help you get started on a cash-out refinance loan in Colorado.

What Is Home Equity?

Put simply, the equity in your home is the portion of your home’s value that you alone have a financial claim in. So, if you bought your home outright, then your home’s equity is the market value of the home. Similarly, if you are like most Americans and you bought your home with a mortgage, then the equity in your home is the difference between your home’s market value and the remaining amount you owe on your mortgage.

For some people, it is easier to think of home equity as the part of your home’s value that you own outright. While you certainly own your entire home, your mortgage lender has a financial interest in your home’s value as long as there is a balance remaining on your mortgage. As soon as your mortgage is fully paid off, the entire value of your home becomes equity.

Perhaps an example of calculating home equity will make things even clearer. Suppose you purchase a home for $100,000 with a down payment of $10,000. At the time of your purchase, you hold $10,000 of home equity, since that is the portion of your home’s value you have paid for in full. Now imagine the market value of that home increases to $140,000. Following that increase in value, your home equity increases from $10,000 to $50,000. Payments toward the principal amount of your mortgage balance also increase your home’s equity, since these payments decrease the overall balance on your mortgage.

This example should make it clear that home equity is a major financial asset for homeowners. At Local Mortgage, we consider home equity one of the biggest benefits to becoming a homeowner in the first place. Although home equity is a major financial asset, it is not a liquid asset. This means that you can’t spend your home equity directly, but rather need to take some steps to transform it into cash.

Tapping into the Value of Your Home

Broadly speaking, there are two common ways to tap into your home equity and capitalize on the value of your home that you own outright. One way to liquify your home equity is to take out a home equity loan. Home equity loans are often called “second mortgages,” since they involve taking out a second loan with your house as collateral. Taking out a home equity loan results in another monthly payment at a different interest rate since it is an additional loan you take on.

Cash-out refinancing provides another way to tap into your home equity. Cash-out refinancing involves refinancing your current mortgage into a new mortgage for a larger amount. The additional amount on your new mortgage covers your home’s equity, and you receive this additional amount to spend as cash. Unlike a home equity loan, a cash-out refinance loan replaces your mortgage, resulting in one monthly payment. This is a great way to turn your home equity into money you can actually spend, while maintaining just a single monthly payment.

Typically, people use refinancing to capitalize on lower interest rates or reduce the term on their mortgage. With the consistently low mortgage rates the market has experienced in recent years, refinancing in this way is often a smart idea, which is why we wrote a blog explaining the common ways to refinance. While cash-out refinancing is not as common as refinancing to reduce rates or term, it can also be a smart idea due to low interest rates.

The Benefits of Cash-Out Refinancing

Cash-out refinancing offers some benefits that home equity loans do not. As previously mentioned, with a cash-out refinance you have only one monthly payment, while a home equity loan results in multiple monthly payments. This can make a cash-out refinance simpler to manage and potentially a more straightforward way to tap into your home equity.

If you took out your mortgage when interest rates were higher than they currently are, then a cash-out refinance might be the best way to access your home equity. With a cash-out refinance, you get the chance to refinance your first mortgage to the interest rates currently on the market. The result of this is a new mortgage for a larger sum, with a lower interest rate. This provides a low cost way to use your home equity while also securing your home at a lower mortgage rate.

Cash-out refinancing is probably the best way to use your home equity if you plan on remaining in your current home. It allows you to stay in your home with one monthly payment, a low interest rate, while also having money to spend from the value of the home. This is a particularly good plan if the housing market in your area heats up and the value of your home increases.

Get Cash Out of Your Home with Local Mortgage

If you would like to learn more about cash-out refinancing, then consider contacting Local Mortgage. Our team of mortgage experts can help use your home equity for home improvements, a rainy day fund, or even to finance a vacation! Apply for refinancing today.