Home Equity for the Newbie Borrower

Equity is defined by dictionary.com as the monetary value of a property beyond any amounts owed on it in Mortgages, claims, liens, etc. Simply, it's the dollar amount difference between what is owed on your property and what it would sell for if you sold it tomorrow. For example, if the total amount owed on your mortgage loan is $150,000, but you could sell your house tomorrow for $200,000, then you would have $50,000 in equity.

There are three ways to benefit from equity in your home. The first of which is to sell your house. Let's use the math above and say your home is worth $200,000, but you only owe $150,000 on your mortgage loan. When you sell your home, your mortgage loan is paid in full and whatever value is left over goes right into your pocket. You have to be careful with this option, however. If your left over portion is more than $250,000, the government will charge a Capital Gains Tax. This number may seem high, however up until May 7, 1997, the only way you could avoid paying taxes on any profit from your home sale was to use the money to buy another, more-expensive house within two years. This is no longer the case unless your profit is larger than the $250,000 mentioned above.

The second option is to use the equity of your home by borrowing against it. This is commonly seen as an Equity Line of Credit. This option allows you to access a revolving line of credit in the amount of the equity value. Checks and online banking transfers allow you easy access to this line of credit, which is paid back like a credit card, every month. Another common form of this is an Equity Loan. An Equity Loan is a set amount that is borrowed at one time and paid back over a set course of time. These usually carry lower interest rates than the more accessible Equity Line of Credit. Be careful of this option however. The market fluctuates and today's high home value could lead to borrowing against next year's foreclosure. I bought my home for $240,000 and, at the height of the housing bubble, had the opportunity to borrow against $400,000 in equity. Now that the housing market has crashed and my house is now worth the original $240,000, I would have had way more debt than I could ever pay off.

A very dear friend of mine, who was in the Real Estate business many years ago, told me that the worst decision one could make when owning a property is borrowing against the equity. He said that you should sell your home and invest in a nicer one or stay put and live in your home through richer and poorer. This is my third suggestion for properly using your equity. My friend's logic is that a well cared for home will serve a higher purpose after it's been paid off and handed down to the next generation to either live in or sell once you've passed on. You must be patient and determined for this method of saving. Invest in the repair and upkeep of the home over time so that it will be worth well more than you purchased it for even in today's economy and housing market.