Home equity is the portion of your home you own outright. As it builds, you can leverage it to access cash or to meet pressing financial goals. This guide dives into the specifics of home equity, how it’s calculated, and how to build and maintain it over time.
What is Equity in a House?
Your home equity represents the difference between your home’s current market value and outstanding mortgage balance or your ownership stake in the property. It grows as you pay down your mortgage principal or as your home’s market value increases.
How Home Equity is Calculated
To calculate your home equity, you need to know your current property value and how much you owe on the mortgage. Here’s the formula:
- Home equity = Current market value – outstanding mortgage balance
To illustrate, assume your home is valued at $315,000, and you owe $205,000 on your mortgage. You’d have approximately $110,000 ($315,000 – $205,000) in home equity.
Factors Influencing Home Equity
The amount of home equity you have can change with local trends, market conditions or if you make upgrades to the property.
Property Value Fluctuations
If there are developments in your neighborhood or the local real estate market, the value of your property could increase, boosting your home equity. But if there’s a downturn due to changes in market conditions or an economic recession, your property’s value could dip.
Market Conditions
To piggyback off the previous point, the real estate market directly impacts your home equity. When the market is thriving and demand for homes is high, inventory levels are generally lower. In turn, property values rise, and your home equity follows suit.
Home Improvements and Renovations
Whether you complete much-needed repairs or renovate your home to make it more livable, its current market value and your home equity could significantly improve. Keep in mind that more common improvements, like bathroom or kitchen remodels and deck additions, could do more for your home’s value. However, overly personalized upgrades or low-quality finishes may not have much of an impact.
Economic Factors
The state of the economy also influences property values, which in turn impact your home equity. In a stronger economy where spending power is high, you may see more inflation that boosts up home values. But when there’s an economic downturn or recession, and unemployment levels are high, home values tend to dip, and so does home equity.
The Benefits of Building Equity
Here are some key reasons why you want to build equity in your home.
Access to Home Equity Loans and Lines of Credit (HELOCs)
You can convert your home equity into cash and use the proceeds however you see fit. Most lenders let you tap into up to 85% of your home equity. To illustrate, if your home is worth $375,000 and your mortgage balance is $215,000, you could potentially access up to $103,750 ($375,000 * .85 – $215,000).
The way you access the loan proceeds depends on whether you take out a home equity loan or a home equity line of credit (HELOC). Here are the key differences between the two:
- Home equity loans: You get a lump sum of cash, payable in equal monthly installments over a set period. The interest rate is fixed, so you’ll know your total borrowing costs in advance.
- Home equity lines of credit (HELOCs): You get a revolving line of credit to pull from as needed during the draw period. It works like a credit card and replenishes as you make payments. When the draw period ends, you make monthly principal and interest payments over a set repayment period. Monthly payments fluctuate since the interest rate is typically variable on HELOCs.
Increased Financial Security
A sizable amount of home equity could also provide you with peace of mind. You can take out a HELOC and use it as an emergency fund if you hit a rough financial patch.
There’s also the cash-out refinance that lets you refinance your current mortgage for more than you owe and pull out the difference in cash. You can borrow up to 80% of your home’s value with this option.
So, if your outstanding mortgage balance is $200,000 and your home is valued at $275,000, you may be eligible for a new home loan of up to $220,000. Here’s the calculation:
- Home equity: $275,000 * .80 – $200,000 = $20,000
- New loan amount: $200,000 + $20,000 – $220,000
If you decide to move forward with the transaction, the new lender will pay off the old loan and send you the $20,000. You’d then get a new loan for $220,000, typically with different terms, and resume repayment with the new lender.
Potential for Higher Return on Investment (ROI)
The more equity you have in your home, the higher your ROI when you sell it. Even if you don’t plan to sell for some time, it helps to know you have a considerable amount of home equity you can tap into if there’s ever a need.
How Do You Build Equity in Your Home?
You can increase your home equity by paying down your mortgage faster, refinancing and improving your home. It’s equally important to keep your property in good condition to preserve its value as it climbs.
Making Larger Mortgage Payments
The faster you pay down your mortgage principal, the more equity you’ll accumulate. Another perk is the ability to pay your home off sooner using this approach. When you pay extra each month, be sure to specify that you want the overage allocated to the principal balance. Also, consider switching to bi-weekly payments to give yourself an extra payment annually.
Refinancing Your Mortgage
You can swap out a 30-year mortgage for a 20-year or 15-year mortgage and pay your loan off faster. It also helps build equity faster, as your monthly mortgage payments will increase, placing a dent in the principal balance faster.
If refinancing gets you a lower interest rate, it could also be beneficial for your home equity. Your borrowing costs will be lower, so a larger portion of your monthly mortgage payments will be allocated to the principal balance rather than interest.
Home Improvements and Upgrades
As previously mentioned, sprucing up your home could increase its value and build equity. When planning your home improvement projects, focus on those that offer the highest ROI to derive the greatest benefit in the near and distant future.
Regular Property Maintenance
Keeping up with your property can be quite a task, particularly if it’s on the larger end. Still, it’s worth investing your time and money into property maintenance to ensure your home’s value continues to grow over time. Buyers like well-maintained homes, so keeping yours in tip-top shape will pay off should you decide to sell.
How to Use Your Home Equity
You generally won’t face spending restrictions when tapping into your home equity. However, homeowners commonly use the funds for these reasons.
Funding Home Renovations
Home renovations can make your home more livable while increasing its value. The more it’s worth, the more equity you can potentially access to achieve financial goals.
Paying Off High-Interest Debt
Some homeowners choose to consolidate high-interest debts using home equity. The interest rates on home equity products are generally lower, and consolidating gives you a single monthly payment instead of several that are challenging to manage.
Investing in Additional Properties
You can also leverage home equity to acquire additional properties and expand your real estate portfolio. More specifically, you can make a down payment on an income-producing property, and as its value grows, tap into those funds as well to continue building wealth through real estate.
Supporting Major Life Expenses
Life happens, and sometimes unexpected occurrences can place a dent in your wallet or wipe out your savings. That’s why some homeowners choose to open a HELOC and use it as an emergency fund if needed.
Conclusion: Strategies for Building and Maintaining Equity
It’s possible to boost your home equity and leverage it to meet financial goals. You can do so by paying more on your mortgage principal, refinancing or making upgrades. Be sure to maintain your home while you live in it to ensure you preserve the equity you’ve worked so hard to build.
Frequently Asked Questions (FAQs) About Home Equity
It depends on the tactic you use. Making a down payment when you purchase a home gives you instant equity. Home improvements and upgrades can do the same once the projects are complete. Paying extra on your mortgage also helps build equity, and the same applies as the housing market strengthens over time, but it could take a bit longer to see the difference.
If market conditions plummet or if you fail to keep up with your home, it could lose equity quickly or over time. The same applies if you take out a home equity loan product.
There’s no perfect answer, but at least 20% could be beneficial for several reasons. You’ll likely qualify for home equity loan products and turn a profit if you decide to sell soon.
