What is home equity? Many homeowners struggle to come up with an exact answer. The definition of home equity is simply the market value of a home less mortgage principal outstanding. However, an owner’s home equity balance changes frequently due to fluctuating home prices and mortgage payments. Keeping tabs on your current home equity is important, though, because it is often a large contribution to a homeowner’s net worth.

Calculating home equity

To calculate home equity, you must first estimate the current value of your home. For comparison purposes, look at recent sales prices in your neighborhood. If your home was recently built or purchased, it’s best to use the price you paid as the market value. From the market value, subtract the principal balance of your mortgage. The easiest way to compute the principal balance is by using a loan payment calculator to break out the remaining payments between interest and principal. The principal is the amount by which your home equity increases with each payment. You will notice as you continue to pay off the loan and build more equity, the interest portion of each payment decreases.

Paying off your mortgage to gain total equity in your home

The most common reasons for early payoff are refinancing a mortgage to gain a lower interest rate or because the homeowner has the ability and desire to own their home free and clear. To begin the payoff process, contact your lender and ask about any prepayment fees or penalties. The next step is to obtain what is known as a payoff balance. Most banks require a request for a payoff balance in writing and have a several-day turnaround. You will owe more than the difference between your down payment and the sale price of your home due to accruing interest. The payoff balance will be as of the exact date you intend to provide funds to pay off the entire loan and will include the accrued interest up to the date.

Leveraging home equity

What is home equity in terms of home equity loans or lines of credit? Home equity loans and lines are financing options available to those who have paid off a significant portion of their home or built up the value of their ownership due to increases in market prices. Home equity lines and loans provide liquidity for property updates such as kitchen renovations or additions. However, borrowing against your home equity leaves you with a lower ownership percentage in your home and, in turn, decreases your net worth. It also puts you at risk of foreclosure if you find you can’t make the payments.

Often, your primary residence is your largest single investment, and increasing home equity is an important way to build wealth. As with any investment, market fluctuations can affect home equity, so consider how much you feel comfortable borrowing against your home before you apply for any type of home equity financing.

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