About Home Equity: The Basics for First-Time Homeowners

Learning about home equity is one of the most important things that you can do as a first-time homeowner. Your home equity could be one of the most valuable resources that you have. Handling your home equity properly should be one of your highest priorities.

Building Equity

The first thing that you need to understand is how your equity is built. When you have a traditional mortgage, a portion of your payment goes towards interest, and the other portion goes towards the principal. When you get started with your mortgage, the equity will build very slowly. You might not notice a difference for several years.

When you start paying a mortgage, the vast majority of your payment goes towards interest. For example, if you have a $1000 mortgage payment, you might be paying $950 in interest. Therefore, you are only accumulating $50 worth of equity in your house for that month. When you have a mortgage for $150,000 or $200,000, it does not seem like you are making much progress. However, over time, the equity will slowly continues to build every month. It is almost like a form of forced savings.

Appreciation

In addition to building equity through your regular mortgage payments, you can also build it through appreciation. Over the course of time, the overall value of your property will increase. During a normal market, most houses will appreciate anywhere from 1 to 3 percent per year. Therefore, you are able to accumulate your equity even faster with the help of appreciation.

Tapping Your Equity

Once you have accumulated enough equity you could potentially borrow against it for a number of different reasons. Your home equity could be one of the best sources of funds when you need it. You could access the equity through a refinance of your existing mortgage, home equity loan, or a home equity line of credit.

When you utilize your home equity through one of these methods, you will be able to take advantage of a huge tax benefit. If you itemize your deductions, you can deduct all of the interest that you pay on your new mortgage or home equity loan. This gives you a major incentive to borrow against your home equity, instead of using other sources of financing.

Importance of Equity

Many people utilize their home equity for many reasons, but it should be reserved for important financial matters. You will be bombarded by promotions and offers for home equity products from lenders. However, you should only utilize it if you have a valid reason. Your home equity is one of the most valuable resources that you have. You need to guard it and make sure that you do not waste it frivolously.

Using your home equity to add value to the house, consolidate debt, or purchase a second property could potentially be good uses of your home equity. However, taking a vacation with the funds or buying a home entertainment system is most likely not the best use of your home equity funds. Guard your equity closely as it could be your last source of funds in an emergency.