How to Build Home Equity

Owning your own home comes with a quite a few benefits, and one valuable asset you gain access to as you pay down your mortgage is equity. Whether you are a new homeowner or you have lived in your current house for years, understanding how your equity stake grows is crucial to utilizing this powerful financial tool.

What is home equity?

Your home’s equity represents the amount of your home that you own outright versus the remaining balance on your mortgage that needs to be paid off. For example, if you have finished paying off your mortgage, or paid for your home in cash, you have a 100% equity stake in your home.

If you are a homeowner who took out a mortgage that you are still paying, then your equity is calculated by subtracting the balance you still owe from the home’s current market value. For example: Say your home is currently worth $450,000, but you still owe $150,000 on your mortgage. That means, the total equity you have in your home equals $300,000.

However, that does not necessarily mean you can access the total amount of equity using a HELOC, home equity loan, or cash-out refinance. Generally, the more equity you have, the more money you can borrow. But lenders also use your loan-to-value (LTV) ratio, credit score, and other factors to determine how much equity can take out in cash.

Is it important to build equity in my home?

There are a couple different reasons why it is important to build home equity, including:

• Having a second source of funds. Many mortgage products offer you ways to borrow against your home equity for almost any purpose, including: home renovations, debt consolidation, or creating an emergency fund.
• Increasing your ability to make a profit if you sell the home. Even if you still have a mortgage balance, having equity improves your chances of selling the house for more than what you owe on the mortgage.
• Building long-term wealth. Your home equity increases your overall net worth over time. Unlike other assets (such as cars, which depreciate), your home is a type of collateral that can potentially appreciate in value.

How to build home equity?

It is important to understand what makes home equity so important to build, but how exactly can you increase it?

Some homeowners prefer to focus on building equity over time by staying on top of their monthly mortgage payments. However, there are a few ways that can help you build home equity more quickly:

1. Provide a large down payment.

The minute you put down your down payment, you start building equity, as this amount is paid out of pocket and becomes your ownership stake in the house. While it is possible to purchase a home with as little as 3% down, a larger down payment will instantly boost your home equity.

However, it is important that you do not completely deplete your cash reserves or savings with this endeavor in mind. It is great if you can comfortably afford a big down payment, but you need to take your closing costs and monthly mortgage payments into account as well.

2. Pay more than the minimum on your monthly payments.

As you make your monthly payments and pay down your mortgage balance, your home equity increases. However, a larger portion of your automatic payments will initially go toward interest. If you are able to make extra payments toward the principal each month, you will be able to build home equity more quickly.

3. Invest in home renovations that increase property value.

Even though the economic factors that determine market value are beyond your control, managing the condition of your house and investing in home improvement projects are great ways to increase its value. Remember, market value is the determining factor in the home equity equation. Whether you remodel the kitchen or install upgraded doors and windows, there are a number of home improvements you can make to help increase your home’s value.

4. Refinance to a shorter loan term.

Choosing to refinance to a shorter loan term can get you a lower interest rate and increases the amount of your mortgage payment going toward the principal balance each month. For instance, a 15-year mortgage will help you build more equity in a shorter timeframe than a 30-year mortgage since you are paying down the debt faster.

There is a catch though, because your monthly payments will be much higher for a shorter-term loan. It is important to double-check your finances and ensure there is room in your budget for larger monthly payments.  

5. Avoid doing cash-out refinances too soon.

If you do decide to refinance your current mortgage, make sure you avoid doing a cash-out refinance too soon. A cash-out refinance replaces your old mortgage with a bigger one, so you can receive the extra money outright in cash. This larger loan is based on the value of the equity you currently have, and borrowing against that ownership stake will reduce it. If your goal is increasing your equity, it is a good rule of thumb to avoid tapping into it too soon. This also applies to taking out a HELOC or home equity loan.

How can I tap into my home equity when I am ready?

There is no one right time to tap into home equity, as the best way to use it looks different for every homeowner. When the time does feel right, there are a few ways to turn your equity into funds, including:

• A home equity line of credit (HELOC)
• A home equity loan
• A cash-out refinance

It is important for every homeowner to understand the powerful benefits of their home equity. No matter what stage of homeownership you are in, be sure to reach out to your lender when you are ready to learn more about your equity options.