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Most people see mortgages as money they are paying back to the bank. But that’s only half the story. When you pay a mortgage, you are also slowly taking ownership of your property. Every month, you add a little more to your equity.
At first the amount you add is small. But eventually, the numbers really start to add up. And eventually, you own your entire home, plus the amount that it appreciates in the interim.
Because of this, you have a store of wealth: money you can access when you need it.
The amount of equity you have in your home is the value of your home, minus the mortgage you need to pay on it.
For instance, if your home is worth $250,000 and you have $100,000 outstanding on your mortgage, then your equity is $150,000.
Most lenders will lend you around 80 to 85 percent of the value of the home. You have to pay the remaining 15 to 20 percent in cash.
This approach makes it much easier to buy a home and it helps to make a person’s economic life more predictable. If you know that you’re locked into paying mortgage payments for 25 years, you are much more likely to take a long-term job or career to finance them.
Just as you put money into your home, you can also take money out of it, as long as you use the right type of mortgage lender.
There are several ways of doing this, depending on the approach you take.
Perhaps the most intuitive is a cash-out refinance. Here you’re taking advantage of the appreciation in your home’s value. Let’s say that your home goes up in value from $250,000 to $300,000. That $50,000 in equity is a new safety margin for the bank. A cash-out refinance means taking out a larger mortgage, say increasing it from $100,000 to $150,000 and pocketing the extra $50,000 in cash.
Another option is to take out a home equity loan. This is where you take out a second mortgage on your property in addition to the first, backed by the extra equity your property gained. Here the bank pays you cash in exchange for mortgage repayments and your home as collateral in the future. Lenders feel safe doing this because if they foreclose your home, they can get the money back they lent you.
The final option is a home equity line of credit. These are revolving balances that work a bit like credit cards. You take out credit based on the value of your property and your credit score. Mostly, rates are revolving, though you can get fixed versions.
People take the equity out of their homes to pay the expenses they need to make today. They do this for college tuition, debt consolidation or home renovations. Usually, they make money available to make some sort of investment.
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