Home ownership brings together so many wonderful things; family, dreams, shelter, status, and perhaps the most valuable factor — equity. Home equity is typically a homeowner’s most valuable asset, and can be used later in life, so it’s important to understand how it works and how to use it wisely.
Let’s take a closer look at how to calculate equity, how to build your equity and how to access it when you need it most.
What is home equity?
Described by many as a forced savings account, home equity is the difference between your home’s market value and what you owe on it. Your home equity grows with each mortgage payment you make, and when home prices rise, your equity grows faster as your home’s value increases; this is called appreciation, which we will cover later on in this article.
How do you calculate home equity?
The easiest way to calculate your home equity is when you first buy a home because it is basically your down payment. For example, if you put $20,000 down on a $200,000 home, your home equity upon purchasing would be 10 percent ($20,000). As you pay your mortgage each month, your home equity will continue to increase with each payment you make. So, if your mortgage payments are $2,000 a month, your home equity should be around 22 percent one year after purchasing your home, meaning that you owe $156,000 towards your home.
How do you build home equity?
To speed up the growth of your home equity, there are a few great options. Some require time, money or both. But all work towards two common goals: to increase your home’s value, or decrease your mortgage debt.
1. Let your home appreciate
Increasing your home equity through appreciation is largely dependent on the real estate market, but for the most part takes time and patience. As your home’s value grows, so does your equity. Using the same example as above, let’s say that your $200,000 home goes up in value by $50,000, bringing the total value of your home to $250,000. With your home valued at $250,000, and you still owing $156,000, you would have around 37 percent equity (1-($156,000/$250,000)). In this case, your loan value has not changed, but your home equity has increased due to the appreciation of your home.
2. Make a larger down payment
You can get equity from the beginning by making a larger down payment. The larger your down payment, the larger percentage of equity you will have from the start. Deciding on a down payment can be difficult, but a good mortgage lender should be able to help you evaluate your monthly expenses and budget so you can make a down payment that makes the most sense for your situation.
3. Make home improvements
Aside from appreciation, you can increase the value of your home with home improvements. Smaller improvements such as new appliances and new paint are not likely to increase the value of your home. But larger home improvements, such as a new kitchen or room additions, can have a major effect on increasing your home’s value. Before you begin any major projects, we suggest doing your research on the exact ROI you could receive.
4. Pay more on your mortgage
Because the amount you owe towards your mortgage is a direct reflection of your home equity, paying more on our mortgage can help you increase your home equity quickly. Here are a few options to consider when increasing your mortgage payments:
a. Earmark one partner’s paycheck. Couples who want to increase their equity in a hurry can take the route of living on one salary while committing the other person’s paychecks to paying down the mortgage.
b. Use gifts, bonuses and windfalls. Look for cash that dribbles in here and there (gift cards, inheritance, overtime pay, bonuses) and put it towards your mortgage to help pay down your principle.
c. Make bi-weekly payments. Paying your mortgage every other week instead of monthly adds one extra monthly payment to your mortgage annually.
d. Boost your monthly payment by an amount equal to a twelfth of a payment. By the year’s end, you’ll have made an extra payment.
How should you use your equity?
Using your home’s equity is allowed, but not advised unless absolutely necessary. To use your home’s equity you must borrow or sell your home. The three most known ways to get to your equity through borrowing are a home equity line of credit (HELOC), home equity loan or cash-out refinance. If you find that you are in a situation where you need to borrow from your home equity, we suggest talking with your lender to determine the best approach for your financial situation.