Real Estate & Finance --- They Are Not the Same Thing
When you own property, you tend to think about paying the mortgage a lot. Like, you're probably counting down the days until your next payment. Well, you don't necessarily think about the fact what you're paying is actually a financial obligation to own the property in perpetuity. That's definitely not your thought every time. The two are related, but very, very much separate.
For example, there are two separate ways of viewing "appreciation", from a real estate stand-point and from a finance standpoint.
True appreciation is a real estate ONLY activity. It involves an areas of a city (let's say Denver) that becomes more in demand (let's say the Highlands) going up in value (let's say 6%) because consumers are willing to pay more to be there (a condo for $300,000 last year costs $318,000). That's the concept of appreciation in terms of SELLING a property, anyway. For someone that owns a house, you wouldn't know truly what your home is worth unless you got yourself a real estate appraisal. That comes in to play during a refinance --- but I'll touch on that later.
In finance, there is no concept of "appreciation", per say, instead we have equity. Equity is a powerful concept. The basic idea is that the true value of your home LESS the balance of your loan EQUALS your dollar value in equity. Take that result and DIVIDE it by the APPRAISED VALUE of your home, and you have your percentage of equity. Equity helps the bank determine that you own more of your home than you did last month. So during a refinance, maybe you initially had 3.5% down on an FHA loan, but suddenly you own 20% of your home and can refinance into a lower monthly payment because you get to use a Conventional loan instead.
Is your head spinning?Finance is stupid-complicated for no apparent reason. Take a look at the example below... remember, real estate and finance are two separate pieces of a mortgage/monthly payment!!
Real Estate Side
1. You bought your home for $300,000.
2. It's now worth $362,500 three years later.
3. If you sold your home, you would now make $62,500.
Finance Side
1. You have an FHA loan balance of $289,500 on your $300,000 home.
2. Monthly Payment is $1,646.85.
3. After three years your loan balance is now $275,500 on your $362,500 home.
4. To the bank you own 24% of your home.
5. You refinance with more ownership of your home into a Conventional loan.
6. Your new monthly payment is $1,395.92 because you've dropped your mortgage insurance and your loan balance is less than when you started.
Does that help? The bank knows your home is worth more and is willing to bet you won't default on your loan. So they can offer you better products at lower interest rates with less mortgage insurance because they are "betting" you don't want to lose your 24% stake ownership. On the flipside, you also "made" $62,500 in real estate appreciation which you can realize by selling your property... but you don't want to do that yet!
So now you are living comfortably with a much less stressful-sized mortgage payment. So although the concepts on finance and real estate intertwine and rely on one another, they are still two separate ways of viewing appreciation. If you bought in cash ---- you'd never even see the financial side. It would all be $$$ in your eye each year the property went up! So there you have it, make a smart financial decision when you own and analyze everything using spreadsheets before jumping in!