Learn About Losing Equity in a House
If you stay in your home long enough, you may see that the equity fluctuates. You can lose equity in a house and later regain it. In certain markets, it can take a long time for equity to make a rebound once it is lost. In other markets, equity can quickly rebound. Sometimes you can lose equity in a home through no fault of your own, while other times you may be to blame—whether or not you knew your actions could impact your home's equity.
For homeowners, a decision might seem harmless, but it could turn out to have profound impacts on your financial situation. By learning more about the ways your home equity can be impacted, you can avoid common (though not necessarily obvious) equity pitfalls. Here are some of the ways in which you can unintentionally lose equity in a house.
What Is Home Equity?
Before getting to ways you can impact your home equity, it might be helpful to remind yourself what exactly home equity is. The number refers to the monetary value you have stored in your property.
For instance, if you buy a home for $500,000 with a $100,000 down payment, your initial equity in the home would be $100,000. As you pay off your mortgage, you own more of the home outright, and your equity increases. When the mortgage is completely paid off, your home equity would be $500,000. If the market has risen since you bought the home, and the home is now worth $600,000, your home equity increases to $600,000, too.
This example scenario assumes that all else remains equal with your home, the housing market, and your personal finances. In reality, homeowners may make decisions that affect their home's equity.
Changing the Structure or Layout of Your Home
When you own your home, you have wide latitude to make changes as you see fit. Want a new paint job in the bathroom? Go for it. Eyeing a wall that could be knocked down? No problem.
However, it's important to remember that not every home improvement project is well planned or wisely orchestrated. Some home improvement projects might fit your tastes, but not the general market's. When that happens, your home loses value. For example, if you reduce the number of bedrooms, paint all of your walls black, or convert a garage into a room addition, you might lose equity in your house.
It can work the other way, too. A well-done remodel of a bathroom can increase the value of your home, as can making energy-efficient improvements.
Refinance a Home Loan by Taking Out Cash
If you refinance your mortgage and take cash out, you have effectively increased the amount of your mortgage loan. If appreciation does not keep pace or home values fall, you could owe more than your home is worth, which would mean you have lost equity.
If you use the cash-out refinance to remodel a kitchen, for example, you might replace the equity you lost, but you must ensure that you can afford the loan and that the remodel will increase the home's value.
Borrowing on a Home Equity Loan
Like cash-out refinancing, a home equity loan is another way to borrow against what you have paid off on your mortgage. That means, when you take out a home equity loan, you are losing some of your equity in the home. Your equity shrinks while your financed loans get bigger.
Deferred Maintenance Will Cause You to Lose Equity
Everything inside your home has a shelf life, from the home's exterior siding to the roofing and windows. Appliances such as HVAC eventually wear out. If you let things deteriorate and never fix or repair anything, you can expect a potential buyer to price those repairs into their offer, and your equity will suffer as a result.
Financial Markets Can Collapse
It happened before, and it could happen again. Housing markets are not immune to crashes, as seen during the 2007 mortgage meltdown. Homes went into foreclosure. Short sales became a household word. Short sales and foreclosures affect the values of neighboring homes.
Somebody Could Die in the House
Many buyers will hesitate to buy a home if there's been a death in the house. It's even worse if the home is stigmatized due to a tragic death. You can lose equity if a person passed away inside the home, regardless of how peaceful, though you may not be required to offer that information upfront.
The Bottom Line
While many people find that their home equity increases over time, there are steps you can take to provide an extra layer of protection. Refinancing or taking out a home equity loan will have the most direct impact on your equity, so avoid those. If you're planning on remodeling, it might be worth consulting a real estate agent to ensure that the project will increase your home's equity, rather than decrease it. Finally, keep up with maintenance so your home doesn't fall into disrepair.