Do you know how much home equity you're sitting on? It's a question worth asking because research published by Fannie Mae in August 2015 suggests many homeowners are significantly underestimating the value of the equity they have in their real property. And that's a serious issue, because it could mean that millions of Americans are choosing the wrong sorts of loans and are closing off other life-changing options.
Home equity, of course, is the difference between the market value of a home and the current balance(s) of the mortgage(s) that it secures. For example, suppose your home is today worth $220,000 on the open market, and the amount you owe on your mortgage this morning is $120,000: You have $100,000 in home equity. Providing your credit score's okay and you can afford the monthly payments, you could use some of your equity to access loans with much lower annual percentage rates (APRs) than if you had little or no equity.
Wrongly assuming you have little or no equity could see you paying much higher APRs (maybe as much as two or three times higher), and having to pay much higher payments every month, to service both existing debt and any new loans you need. Equally, you may be wrongly assuming you can't move homes, refinance, or, if you're a senior or near-senior, have a reverse mortgage. Knowing how much equity you have in your home lets you identify your financial options.
Combining data from its own National Housing Survey with others from property analyst CoreLogic, Fannie Mae found a truly remarkable difference between homeowners' assumptions about their equity and reality. In December 2014, just 37 percent of homeowners with mortgages believed they had significant equity (20 percent or more). In reality, 70 percent did. That's astonishing.
Unfortunately, some homeowners still really do have no equity. CoreLogic reckons 10.2 percent of all mortgaged homes in America were "underwater" (had negative equity, meaning the mortgage balance exceeded the property's market value) in the first quarter of 2015. The good news is that percentage is way lower than it has been in recent years, and 254,000 homes regained equity just during those three months between January and March.
However, many people think their homes are still underwater when they're not. In the first quarter of this year, when 10.2 percent of homes were actually in negative equity, more than twice that percentage of homeowners (22 percent) believed theirs was, according to Fannie. Given the stress that negative equity can bring, that's plain sad.
The Privileges of Home Equity
Some homeowners see their equity as an important part of their savings strategy and would only touch it as a last resort or as a down payment on their next home. But many others are happy to tap into it when necessary, perhaps to consolidate expensive existing debt, to cover or contribute to the cost of a major event such as a wedding or college education, or simply to provide them with more flexibility as they manage their living expenses. There are virtually no limits on how the proceeds of this type of borrowing can be spent.
Depending on their needs and circumstances, borrowers may choose from a number of options, all of which are almost always much cheaper than other loans. These include:
- A cash-out refinancing – This gives you a whole new mortgage, and is likely to come with both the lowest APR and the longest payback period. But it takes more time and costs more money to set up one of these. Learn more about refinancing.
- Home equity loan – You borrow a lump sum and make equal monthly payments. Learn more about home equity loans.
- Home equity line of credit (HELOC) – A little like with a credit card: you get a credit limit, and can borrow, repay and borrow again as often as you like up to that limit. But these are complicated, and you need to read the Top 10 FAQs About HELOCs.
Reverse mortgages can also be counted among these products. However, these are available only to those ages 62 years and over. Before going too far with one of these, read 5 Reasons a Reverse Mortgage is Not for You (and What to Get Instead).
It's important to recognize why loans based on your equity are much cheaper than most other forms of borrowing. It's because you're putting up your home as security. In other words, you could face foreclosure if you fall too far behind with payments on any of these products. That's not an issue for many people, as many are confident they'll be able to meet payment schedules. But if your financial situation is precarious, or is likely to become so, you might be better off sticking with more expensive unsecured borrowing.
How Much Home Equity Do You Have?
Unless you have a friend or family member who's a local real estate agent, it can be hard to keep track of home prices in your neighborhood. And it is those you need to follow. National, regional and even state or county averages are of limited use.
So this is going to take a little research on your part. By all means, use national online resources that allow you to type in your address to get a valuation. But those are necessarily rough-and-ready approximations. You might be better off using local real estate agents' websites, but don't rely on advertised asking prices from there or any other source. Any owner can ask any amount for a home, and there can be a wide gulf between an asking price and a sale price. However, if a local agent has a free online appraisal tool that asks you questions about your home before suggesting a value, that might be more helpful.
However, a better, more accurate method is to keep an eye out for neighborhood home sales and make a list. You can then probably log on to your county recorder's website and find the actual sale prices. If that's out of date (many have backlogs), call and ask for the information. These are public records and you're entitled to know.
You have to then make a sensible comparison between the homes sold and your own. Be realistic here. A fantastic yard, for example, will certainly add value, but not always as much as you'd think. Similarly, you can't take the recent sale price of an identical home and add $20,000 just because you spent that on a new kitchen last year. Again, buyers will pay more for a great kitchen, but rarely the full cost. If you struggle with this, you may decide it's worth paying a professional appraiser. Expect his or her fees to be roughly $300 to $400.
To determine your equity, just deduct from the value of your home from your current mortgage balance. Check your most recent statement, look online or call your lender for that.
The important point is this: Knowing your equity empowers you because it may open up options you thought were closed to you. And, even if you're disappointed with the result, you may be encouraged by how near you are to having more of those options available.