Equity

The main reason that most people buy a house is to have a place to live. A secondary benefit of owning a house is the accumulation of equity. Equity represents the portion of your house’s value that you own. A basic formula would be: equity is equal to the market value of your house minus the total of your mortgage.

For instance, imagine your house is worth $100,000. You paid a $15,000 down payment and obtained a home mortgage of $85,000. Over time, you have paid down your mortgage to $70,000. Your equity, in this scenario, would be $30,000.

When you first begin making payments on your home mortgage, the better part of your money goes toward paying the interest. As time goes on, a greater portion of your payment will go toward the principal. In other words, equity builds slowly at first, but faster over time. Home mortgages with shorter terms (15 years instead of 30) help borrowers build equity more quickly.

A house is typically not a high-return investment. For that, you would choose a more aggressive medium like the stock market or a mutual fund. Still, building equity through your home mortgage can help you obtain cheaper financing in the future. For instance, you can borrow money against your equity. With a home equity loan, you can usually get low interest rates that are tax deductible.

Alternatively, you can trade in your equity for a new loan. This is called refinancing. Refinancing can help you afford major expenses like college tuition, weddings, or the purchase of a second home.