Home Equity: Educating Homebuyers on an Important Topic
For clients, having equity in their home can have a dramatic impact on their personal finances. The more equity your clients have, the greater their financing options will be on future purchases. With enough equity built up in their home investment, it can even help them avoid paying for private mortgage insurance on a home loan.
But any mortgage client with a novice home seller and buyer can tell you – not everyone knows how best to understand the concept of home equity. So just what is equity, and how can your clients determine how much of it they built up in their home? In this guide, we explain equity and share how you can help your clients to figure out how much equity they have already built up in their home.
Educating Clients: What Is Home Equity?
Equity is the difference between what a client’s home is valued (or appraised) at on the current market and what their mortgage balance is. So, if a home has a market value of $300,000 and your clients have a mortgage loan balance is $175,000, then they have built up $125,000 of equity in the home.
Does Home Equity Change?
Educate your clients that home equity is never a static figure. It varies based on certain factors, most importantly the market value of the home. If the market drops, then so does your client’s home equity. If housing values rise, then the equity rises. If the market stays the same, then the amount of equity they have will grow as they continue to make payments.
Likewise, if the market crashes, causing home values to plummet, then your client could wind up with no equity and/or have a home in which they owe more on it than what it’s worth.
Calculating Loan-to-Value Ratio With Mortgage Clients
If your client is applying for other types of loans after they’ve purchased their home, let them know that lenders like yourself will often look at loan-to-value ratio when deciding whether to approve an application. They’ll want to know that loan-to-value ratio is also what is used by mortgage companies to determine if they need to pay private mortgage insurance (PMI) on a loan.
Further, make sure to inform them that most lenders require at least 20% of the selling price down to avoid this monthly fee. If a client doesn’t put 20% down on a home, then the PMI charge will automatically drop off the loan when their loan-to-value ratio hits 78%. Or, if they made extra loan payments and their LTV ratio reaches 80% earlier than planned, then they can request that their lender cancel their PMI.
Here’s an example with a solid set of numbers you can use to further help clients visualize this information. To figure out loan-to-value ratio, you take the amount you owe on your home loan and divide it by your home’s appraised value. Using the figures from above, this would be 175,000 divided by 300,000. The answer is 0.58. Next, multiply the answer by 100 and you get 58. Therefore, your loan-to-value ratio would be 58%.
How Clients Can Increase Their Home Equity Faster
Let your clients know that the more they pay toward the principal of their loan, the more equity they gain in the home (if there are no declines in the market). If they have a standard 30-year mortgage, then most of their monthly payment will be applied to the interest on their home, with very little going toward the principal. After 15 years, the monthly payment is mostly applied to the principal, so they won’t see a substantial gain in equity until they have passed this threshold.
If they want to increase home equity faster, then they should make an additional payment to their lender every month. Whatever amount your clients pay for a second payment, it’s then applied directly to the principal on the loan, as long as they paid the first payment in full.
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