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I am a relatively new home owner, having purchased my first home in October 2009. It was a $315,000 home, purchased with a 5% no-cost loan with I believe 12% down payment. I think the total financed amount was $283,000.

I understand that the dollar value of my equity is the home value (which I think is currently $318k) minus any outstanding loans/liens/etc. on the home, which at the moment is just the mortgage, currently around $270k. That would give me about $48k in "equity".

While I understand that equity is the dollar value stake that I have in my home, what exactly is the value of that equity? What are the benefits of having it? Are there any detriments to having it?

I've heard the phrase "taking out your equity" in relation to refinancing... what exactly does that mean, and what are the benefits or detriments of doing so?

Despite owning a home, I'm not entirely certain I fully understand the value of having equity, and what role it plays in home ownership, refinancing, or eventual sale of my home.

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Taking out your equity when refinancing means that you take out a new loan for the full value of your house (perhaps less 20% as a down payment on the new mortgage, otherwise you'll be paying insurance), pay off your old lender, and keep the rest for yourself.

The result is much the same as using as a HELOC or home equity loan (or a second mortgage), except it's all rolled into a single new mortgage. The advantage is that the interest rate on a first mortgage is going to be lower than on HELOC or equivalent, and the equity requirements may be lower (e.g. a HELOC may only let you borrow against the amount of equity that exceeds 25% or 30%, while a new mortgage will require you only to have 20% equity).

This is especially attractive to those whose homes have appreciated significantly since they bought them, especially if they have a lot of high-interest debt (e.g. credit cards) they want to pay off. Of course, rolling credit card debt into a 30-year mortgage isn't actually paying it off, but the monthly payments will be a lot lower, and if you're lucky and your home appreciates further, you can pay it off fully when you sell the property and still have paid a lot less interest. The downside is that you have turned unsecured debt into secured debt, which puts your home at risk if you find yourself unable to pay.

In your case, you don't yet have even 20% equity in your home, so I wouldn't recommend this. :-)

Equity is simply the difference between the amount you still owe on your home and the amount you'd get if you were to sell it. Until you do sell it, this amount is tentative, based on the original purchase price and, perhaps, an intervening appraisal that shows that the property has appreciated. That is really all that it is and there's nothing magic about it, except that since you own your home, you have equity in it, while as a renter, you would not.

It used to be (decades ago, when you needed 20% down to get a mortgage) that selling was the only time you'd be able to do anything with the equity in your home. Now you can "take it out" as described above (or borrow against it) thanks to various financial products.

It is sometimes tempting to consider equity roughly equivalent to "profit." But some of it is your own money, contributed through the down payment, your monthly principal payment, and improvements you have made -- so "cashing out" isn't all profit, it's partly just you getting your own money back. And there are many additional expenses involved in owning a home, such as interest, property taxes, maintenance, utilities, and various fees, not to mention the commissions when you buy or sell, which the equity calculation doesn't consider.

Increasing equity reflects that you own a desirable property in a desirable location, that you have maintained and maybe even improved it, that you are financially responsible (i.e., paying your mortgage, taxes, etc.), and that your financial interests are aligned with your neighbors. All those things feel pretty good, and they should. Otherwise, it is just a number that the banks will sometimes let you borrow against. :-)

  • Aye, I am not actually looking to take the equity out of my home. I am more interested in understanding exactly what the equity I have does for me? You've somewhat answered that when you discussed the downside of turning unsecured debt into secured debt, and risk to the home involved there. Seems to indicate that keeping the equity in your home rather than taking it out puts you in a better position when it comes time to sell? – jrista Jun 16 '11 at 22:24
  • I'll add some further thoughts on those issues. – kindall Jun 16 '11 at 22:32
  • +1 for points all around, especially secured/unsecured debt, and the mentioning the "costs" of equity (tax, maintenance, etc.) – Nicole Jun 17 '11 at 17:24
  • @jrista in response to your comment, the most important thing to remember when thinking of the "value" of equity (which kindall did address, just worded differently) is that sales prices are volatile and dependent largely on both the buyer's and seller's motivations, so any valuation of equity is going to have a relatively large margin of error. – Nicole Jun 17 '11 at 17:27
  • The only other thing I'd add to what Kindall has above is that 'taking your equity out' via getting a loan (or a larger loan on a new house) is NOT FREE, since you now need to pay interest, for many years, on that money. Just looking at the total you end up paying towards interest on a typical home loan, over the life of the loan, is very sobering. It's one reason I'm more inclined to view the equity as an investment I'll get back when I sell – Chuck van der Linden Jun 17 '11 at 21:04
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A person can finance housing expenses in one of two ways. You can pay rent to a landlord. Or you can buy a house with a mortgage. In essence, you become your own landlord. That is, insta the "renter" pays an amount equal to the mortgage to insta the "landlord," who pays it to the bank to reduce the mortgage. Ideally, your monthly debt servicing payments (minus tax saving on interest) should approximate the rent on the house. If they are a "lot" more, you may have overpaid for the house and mortgage.

The advantage is that your "rent" is applied to building up equity (by reducing the mortgage) in your house. (And mortgage payments are tax deductible to the extent of interest expense.) At the end of 30 years, or whatever the mortgage term, you have "portable equity" in the form a fully paid house, that you can sell to move another house in Florida, or wherever you want to retire.

Sometimes, you will "get lucky" if the value of the house skyrockets in a short time. Then you can borrow against your appreciation. But be careful, because "sky rockets" (in housing and elsewhere) often fall to earth. But this does represent another way to build up equity by owning a house.

  • The important point to keep in mind is that we humans practically need a place to live, a roof over our heads. It's practically a non-optional expense. If you rent, that expense is completely lost. By buying a house on a mortgage, you will be able to recuperate part of those expenses eventually. When you pay off the mortgage you will own the house and be able to sell it. – Björn De Meyer Aug 11 '17 at 23:51
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The equity you have is an asset. Locked away until you sell, and sometimes pledged as a loan if you wish. The idea that it's dead money is nonsense, it's a pretty illiquid asset that has the potential for growth (at the rate of inflation or slightly higher, long term) and provides you an annual dividend in the form of free rent.

In this country, most people who own homes have a disproportionate amount of their wealth in their house. This is more a testament to the poor saving rate than anything else. For me, a high equity position means that I can sell my home and buy a lesser sized house for cash. I am older and my own goal (with the mrs) is to have the house paid and college for the kid fully funded before we think of retiring. For others, it's cash they can use to rent after they retire. I hope that helped, there's nothing magic about this, just a lot of opinions.

  • Yeah, that helps, thanks. I think financially I am in a pretty good position, as my savings (I am using the term a little loosely, as good chunk of that is spread around stocks, IRA/401k, and precious metals) are larger than my current equity. As an addendum...would it be sound fiscal policy to try and maintain an even ratio of equity to savings? Or if equity grows and does become the larger portion of my wealth the longer I own my home, is that simply a normal side effect of longer home ownership? – jrista Jun 16 '11 at 23:28
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    Well, if one's home is 3-4 times their annual income, but you need 16-20X your income to retire and draw 70-80% of your preretirement income, it balances out over time. Usually the house comes first, other savings grows over time.... – JoeTaxpayer Jun 17 '11 at 2:01

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