Recently, we wrote an article about how to build equity in your home. We discussed topics like making larger mortgage payments, funneling extra income (bonuses, gift cash, etc) into the mortgage, and even waiting for time to simply increase the value of your home.
But one aspect was missing: Why does high equity matter? After all, if you’re still making payments on the home, does it really matter if you have 30% equity, 50% equity, or 70% equity?
High equity can have clear advantages. Besides being closer to finally paying off the home and having no mortgage payments, higher equity can bring a variety of benefits to homeownership.
The Advantages of High Equity
Closer to Paying Off the Home
For most people, this is the big one. It’s the reason they diligently make routine payments every month, why they place extra dollars into their mortgage. Reaching no mortgage payments is an important goal for many people. This is, of course, not just high equity, but the highest of equity: 100%. When you have high equity, it means you are closer to finally paying off the mortgage and reaching complete homeownership.
Imagine your life without any mortgage payments. How much would that mean to your monthly expenses? $1,500? $2,000? $4,000 a month? With that extra cash, you could travel the world, purchase a boat, and be even more generous than you are now. That’s the goal for many people, and it’s the reason that so many want to finally pay off their mortgage.
Access to Home Equity Loans
While paying off the mortgage is a noble goal, there are also advantages with high equity that have more to do with maintaining and strengthening your borrowing power. A home equity loan highlights this advantage.
A home equity loan is simply another loan that uses the same property to secure your financing. It also goes under the name of “second loan” or “term loan,” depending on the product. Essentially, this is when a mortgage lender lets you borrow against the equity in your home, and it is repaid every month in addition to the mortgage you already have.
Access to HELOCs
Unlike a typical home-equity loan, a HELOC, which stands for “Home Equity Line of Credit,” is simply a line of credit from which you can draw funds. Everything you borrow is secured by your house, so you can usually enjoy superior terms, such as lower interest rates, that other lines of credit like credit cards can’t provide.
You may, for example, have a HELOC for $50,000. That doesn’t mean you are borrowing $50,000, it simply means that you have access to $50,000 in financing should you need it. Usually these lines of credit have a draw period, such as 10 years. Once the draw period is up, you have a repayment period, which can be around 20 years depending on the financing.
Eliminate Mortgage Insurance
If your loan is large enough, mortgage insurance can cost hundreds of dollars a month and add up to thousands of dollars a year. To eliminate the expense, you need to reach a certain level of equity; usually about 20%.
Less Money Needed Next Time You Buy
If you have high equity, you’ll need less money the next time you make a purchase. This can mean you have smaller mortgage payments in the future, or you could be able to afford a shorter loan period because of smaller payments.
Suppose you have a home valued at $600,000, on which you have 50% equity. This essentially means that you own $300,000 of the property, while the bank, lender, or credit union owns another $300,000. Now suppose you want to purchase a home worth, say, $750,000. When you sell the house (for $600,000, we’ll assume), you have to pay back the bank their remaining half, leaving you with $300,000 that can be used towards the purchase of a property. This means you only need to borrow $450,000 to make the purchase, and that doesn’t include any other savings you can put into the loan.
But what if you only own, for example, 20% of the $600,000 home? In this case, you would own $120,000 of the house while the bank owns $480,000. So when you sell the house for full value, you need to repay the bank their share, leaving you with $120,000. For a $750,000 home, you would now have to borrow $630,000.
This is an extreme and overly-simplified example, but it highlights the differences between low and high equity.
Makes Refinancing Easier, More Affordable
Refinancing a mortgage can bring greater affordability to your monthly finances, allowing you to enjoy lower payments with more spending flexibility. Refinancing can lower interest rates or extend the terms, both of which could mean lower monthly payments.
But you need equity to refinance. Most lending organizations will require around 10% to refinance. If you have less than 20% equity in the property, you’ll likely need to pay mortgage insurance on the refinanced loan. But if you have higher equity, this insurance cost can be eliminated from your mortgage.
What are the “Risks” to High Equity?
“Risks” may not be the right word. A better way to phrase it would be “missed opportunities.” If you are adding additional cash to your mortgage, you miss the opportunity to use this money on other options.
There is the missed opportunity to enjoy the money, but there is also the fact that you are missing investment opportunities. Imagine you’re a 25-year-old with a new mortgage. One day, you get an inheritance from a long-forgotten great uncle who left you $50,000. (25 years-old again, with cash! Sounds great, right?) If you put that money into your mortgage, you’re that much closer to repaying the loan, and it could put you over the 10% or 20% thresholds, depending on the details of your loan. But if you do, you’re missing the chance to invest this money in the stock market, which, if managed wisely, could turn it into millions over the course of a lifetime. That’s a missed opportunity.
Put Your Equity to Work for You
If you are interested in using your equity for a refinance or HELOC, or if you simply want to use your high equity towards a larger, more luxurious home, let us help.
Contact us today for the mortgage support and guidance you deserve!