Many people envision to pay off their house-mortgage on or before they retire to build up equity (the difference between the value of the house and the mortgage owing against the property).
To make a simple calculation of the equity of your house, assume that you will sell your house. The estimated selling price minus agent’s commissions, legal fees and disbursements, and existing mortgages, the amount left is your equity. Legal fees and disbursements and agent’s commission are about ten percent of the selling price.
If the selling price (or present value) of your house is $300,000 less ten percent for agent’s commission, legal fees and disbursements, and let us assume your mortgage balance is $150,000 then, the equity of your house is $120,000 ($300,000 less 10% less $150,000). If you sell your house you can get the full amount of your equity – $120,000.
However, if you borrow against the equity of your house you can get only up to seventy five percent of the value of your house on a conventional mortgage. You may get up to ninety percent of value of your house on a high ratio mortgage, but it would cost you more in insurance premium or higher interest rate on a second mortgage.
When you borrow against the equity of your house if your amortization period is less than 25 years it will go back to 25 years again to pay off your mortgage for you to pay a minimum monthly payment.
Some homeowners do not know that the length of time in paying off their mortgage would become longer every time they take out their equity if they chose the lowest monthly payment
A good example was a caller who asked information on how to take out the equity of his house. He did not need consolidation because he was able to manage his finances properly. The only reason he wanted to take out the equity of his house is because his friends advised him to do so, so that he could use it for his vacation and good time. When I told him that it would prolong the time in paying off his mortgage, he was surprised for he did not know that it would affect the length of time in paying off his mortgage.
You may use your equity if you really need to consolidate your debts to improve cash flow, for worthwhile purpose such as education, home renovation, and sound investment.
Knowing the implications of taking out your equity, do not touch it unless it’s for a worthwhile purpose.