With each and every mortgage payment a homeowner makes to their lender, a little bit more of their home becomes theirs. This basic concept—called equity—works throughout the life of the loan until the loan is paid off. At that point, the homeowner officially owns their home and the land associated with it. It’s a pretty cut and dry concept, of course, but there’s more to your equity than simply paying off a loan balance.
You see, housing prices vary greatly depending on a wide variety of factors. Some of these factors include geographical location, the overall health of the national economy, the health of the local economy, the amount of jobs that are available in the area, the state of the area’s school districts, accessibility to highways and other major thoroughfares, and the presence of amenities like city parks, shopping destinations, restaurants and more. In other words, the makeup of a home’s value is a very complex and constantly changing thing. This is why if you take a cookie cutter four-bedroom colonial and place it in four different geographical regions—say, San Francisco, Raleigh, Pittsburgh and Augusta—you’ll get home values ranging from a modest $150,000 to an extraordinary $2 million.
Home Value Fluctuations
The same thing happens to every home in America—although to a lesser degree, of course. A home purchased in a lightly populated suburban area with no local retail draw, a lengthy drive to the nearest highway access and a struggling school system may have sold for $200,000 a decade ago. In that time, the schools may have improved, urban sprawl may have occurred leading to the development of more homes in the immediate area (increased desire for the location), and in turn, more commercial opportunities have presented themselves. These great things improve your home’s value, and today, that $200,000 home could have a value of $275,000.
Of course, the opposite can also occur. Depreciating home values can occur for many reasons, and no home is infallible. A decrease in your home’s value of just $10,000 can mean taking a real hit once you own the property. After all, no one wants to own a property that’s worth much less than they paid for it.
Protect Your Equity: Use It
We all have the same hopes and dreams when it comes to being homeowners: we want to own our homes outright. However, what you do during the time in which you’re paying off your home is critical to you getting the best bang for your buck, so to speak.
When home values rise, it’s important to take advantage of your increased home value by protecting your equity while the housing market is thriving. Of course, if your home has shown a decrease in value consecutively for a couple of years, you also want to protect the equity you have in your home from falling further. To do so, refinancing your home and cashing out some of that equity is a great option. Refinancing while mortgage rates are low—as they are currently—will help to protect your equity, lower your monthly payments and also possibly reduce your mortgage term so that you can get your home paid off faster.
An Example: Joe Schmo
For example, if Joe Schmo took out a $200,000 mortgage 15 years ago at a rate above 5% interest, we know that he’s built up a great amount of equity in the 15 years he’s been paying on his home. Home values in Joe’s neck of the woods are currently on the increase, and his home is now appraised for $240,000. He decides that now is the right time to refinance, as he sees that mortgage rates are at historic lows. Joe decides to refinance his mortgage and locks in a much lower rate.
He also decides to cash out—or liquidate—some of his equity and put it into a high yield savings account, where it will gain interest. He also lowers his new mortgage’s term to match the 15 years he had left on his 30-year mortgage. In Joe’s case, he’ll end up with a payment similar to what he was paying before, if not even a little bit less; he’ll own his home outright in the same amount of time and he has reduced the amount of interest he’ll pay through the life of the loan by obtaining a lower interest rate. And now he’s got a nest egg at the ready. Joe protected his equity and is enjoying its many perks.
Are You Making the Right Choices?
Many homeowners mistakenly view refinancing and cashing out a portion of their equity as a mistake, but that is certainly not the whole truth. Cashing out and protecting your equity is about applying a strategy to your new mortgage—not just getting a cash payout. That cash payout is critical, however, because it means that you’ve got liquid funds at your fingertips in case of an emergency, to use for retirement, to pay off credit card debt, student loans or medical bills and more. But that’s only part of the strategy. Many forget the rest.
Matching your shortening the term of your refinanced mortgage is a critical component to an excellent financial strategy and protecting your equity. Refinancing your home every so often replacing a 30-year mortgage with another 30-year mortgage is where the problems lie. The term is important. No one wants to be paying off a home while in retirement.
To find out how you can protect your equity and form a solid financial strategy that will help you to better your personal situation, contact one of NLC Loans’ personal mortgage advisors today toll free at (877) 480-8050.