The Reasons for Home Equity
Buying a home is a personal and financial goal that many workers hope to achieve at some time during their lives. Home ownership is expensive due to costs like interest, taxes and maintenance, but it can be less expensive than renting in the long-term. Home ownership also allows you to build home equity, which can be an additional incentive to buy a home.
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Home Equity Basics
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Home equity is the difference between the value of a home and the amount that you owe on any debts taken out against the home, such as the mortgage. In other words, home equity is the amount of a home's value that you actually own. For example, if you buy a home that costs $200,000 and take out a $150,000 mortgage, you have $50,000 worth of home equity. As you make mortgage payments, the balance of your outstanding debt falls, which causes your home equity to increase so long as your home's value doesn't fall.
Homes are Assets
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One of the primary reasons people buy homes and build home equity is that homes are assets that have the potential to increase in value. Similar to stocks, the value of homes can fluctuate based on market supply and demand. When demand for housing is high, it can cause the prices of homes to increase, which increases the equity of homeowners. Home prices have tended to trend upward in value over long periods of time, which means home equity can act as an investment.
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Home Equity Loans
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Another reason it is advantageous to build home equity is that home equity can act as a source of collateral to access low-interest loans. A home equity loan is a type of loan where you offer up some of your home's equity as a security for a loan. Lenders typically charge lower rates on home equity loans than they do on unsecured private loans, which can result in significant savings on large debts. In addition, interest paid on home debt, such as mortgage interest and home equity loans, is eligible for tax deduction.
Avoiding Private Mortgage Insurance
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The amount of home equity you have can determine whether you have to pay for private mortgage insurance. Private mortgage insurance is a type of insurance that mortgage lenders may require you to purchase if you make a down payment that is less than 20 percent of a home's value. When you have little or no equity in a home, lenders consider you more risky to lend to, so they typically require mortgage insurance to guard against the risk of default. Owning at least 20 percent of your home can also allow you to avoid private mortgage insurance if you decide to refinance your mortgage.
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