Home equity is how much of your home you actually own while paying on a mortgage. With every payment you make on your mortgage, your equity increases and you own more of your home. As a first time home buyer, this equity becomes a good way to obtain other loans to purchase appliances or make home improvements.
Equity is calculated by taking the current market price of a home away from the remaining mortgage balance. As you pay off a home mortgage, you are building equity. For example, if your home is currently worth Php 5,000,000 and you have Php 4,000,000 left to pay on the mortgage, then you have Php 1,000,000 of equity.
What Can I Do With Equity?
Equity is not quite like having the money in the bank. While you are still paying on your mortgage, the mortgage holder, possibly a bank, still owns the home. When you have completely paid off the mortgage, the home becomes yours. During the time you are paying on the mortgage, you are building equity which can be used to obtain a loan.
Equity is used to determine net worth and for obtaining loans. When someone asks you "How much are you worth?", they want to know how much money you have that's not tied up in other debts. This would be the money you have in bank accounts as well as your current home equity. This is important to a lender with whom you are trying to make a large purchase, such as a new car.
A popular type of loan for which equity is useful is called a home equity loan. This type of loan is helpful when you have to finance something expensive, like a wedding or college tuition for one of your children. The amount of the loan you can get will be based on the amount of equity you have in your home.
Types of Home Equity Loans
There are two types of loans you could get with your equity. The first type is simply called a second mortgage. With this type of loan, you get a lump sum of money based on your equity. You will start paying back this money immediately and will also be charged interest right away.
The second type of home equity loan is the line of credit. Again, the amount of this loan is based on the amount of equity you have. But, instead of the lump sum, you get a checkbook or debit card that you use to access the loan amount. You start paying on this loan when you start spending the money. You get charged interest only on the money you spend.
For example, a common use of home equity loans is to improve the house. Let's say you wish to build another room onto your home. You get an estimate of Php 2,000,000 from a builder to do the work. You could get a second mortgage for Php 2,000,000 and hand the check to the builder.
Or, let's say that you have several cosmetic things you wish to do to the house and yard over the next year, and you are doing the work yourself. You could get a line of credit and use that every time you go to the home improvement store to purchase what you need as you work on the house.
How To Build Equity
There are some ways, besides making your monthly mortgage payment on time, to increase your home equity.
You can make extra payments to the mortgage principal. Every peso you add to the principal means a peso of equity you gain. By adding a few extra pesos every month to the principle, you will quickly earn more equity in your home.
Another way is to refinance your home to get a mortgage with a shorter term. This means you will be paying more every month, but the number of months you pay will be less. Each month you will gain more equity than with the longer term mortgage.
When considering how to build equity, home improvements
are very helpful. Real estate in the Philippines is in demand now so any home improvements will likely increase the market price of your home
. In the example above of adding a room, your home will be worth more and you'll have more space to enjoy. The higher market value of your home also means you'll have more equity in it.