First-Time Homebuyer: What Is Home Equity?

The first time you buy a house you may hear several terms you don't know. One of these terms is home equity. While it may be a little confusing at first, it's important to understand these terms before closing on a house.

So, what is home equity? Why is it important? How can you build your home’s equity? And what does market value have to do with it?

What is Home Equity?

Home equity is the difference between how much your house is worth today and the amount you owe to pay for it. The size of your home equity depends on three things:

• Your original mortgage amount compared to the home’s value (your original equity)
• The amount you have paid down on your mortgage loan since then
• Any increase (or decrease) in the value of your property since then

In essence, home equity is how much money you would keep if you sold your home today. If you want to estimate how much equity you might have in your home, here is an easy way: subtract the amount you still owe on your mortgage (the principal balance) from your home’s current market value.

How do you find the current market value of your home? Do a search online on websites like www.trulia.com or look at your most recent annual property tax statement. The market value of your home is often somewhere between those two.

How do you find how much you still owe? Look at your most recent mortgage statement from your lender. (Important note: If you received down payment or purchase help in the form of second mortgage loans and any of those need to be repaid, be sure to add those amounts to your mortgage balance to find out how much total you must pay back.)

Why is Home Equity Important?

Owning a home has many advantages: it’s a stable place, you can develop relationships with neighbors and your community, and if you have kids they can stay in the same school. If you buy wisely, your home can also become a financial asset to you. Building equity in your home is a long-term investment strategy. Home equity increases slowly, but the longer you live in your house, the more potential home equity you can build.

So, each time you make a monthly house payment, imagine it like making a regular deposit in a savings account. The money you pay on your mortgage, plus any increase in the home’s value, is money that you could get back when the house is sold.

Paying Down Your Mortgage Loan Principal

It's important to understand that only a portion of your monthly mortgage payment goes towards the principal (or balance). Mortgage payments are amortized - broken down into payments of interest and principal - and a large portion of the initial payments is designated for interest, rather than going towards the principal. While your monthly payment stays the same each month, over time a bigger part of each monthly payment goes to pay down this balance.

Using a loan amortization calculator can help you visualize how much of the mortgage you pay goes towards interest and how much goes into your home equity. As time passes, the balance of the loan decreases and the owner pays more towards the principal rather than the interest on the loan, thereby increasing your home equity.

Market Value is the Key to Home Equity

Keep in mind that property market values — the amount a buyer may be willing to pay for your house — fluctuates over time. Hopefully, the value of your home will go up during the time you live in it, but an increase in value is not guaranteed.

The amount that your property increases in value over time will directly affect the amount of home equity you have in the property. Since that can be difficult to picture, we show three possible scenarios below - when the home value rises, when it stays the same, and when it actually falls below the purchase price.

Conclusion

Home equity can be a smart way to build up your assets and have money tucked away that you can count on later in life, all while living in a home that you love.

And buying a home through Twin Cities Habitat for Humanity, where you can be sure you’re able to afford your home, can be a smart way to build up your assets! Learn more about our Homeownership Program.