Building equity through homeownership is the primary way most people build wealth to achieve financial stability and security. Each monthly mortgage payment that pays down the principal of your home loan adds equity. The more equity you have in your home provides a financial resource you can convert to cash when expenses arise, put towards buying a larger home or second home, save for your retirement or pass on to your family.
What is home equity?
Home equity is the value of the portion of your home that you own. To calculate how much equity you have attained, subtract your current mortgage balance from the market value of your home. For example, let’s say the market value of your home is $350,000, and you owe $150,000 on your mortgage. You subtract $150,000 from $350,000, which equals $200,000 of equity. Your home equity can increase as you reduce your debt by making your mortgage payment each month or as the market value of your home increases. However, your equity can also decrease if your home’s market value drops faster than you are paying off your home loan.
How to build equity in your home faster?
There are several ways to build home equity. Depending on your goals and your current financial situation, you can take any one of these approaches toward building equity.
1. Increase your home’s property value
Your home’s property value plays a vital role in calculating your equity, so the higher the property value, the more equity you receive. You can increase your home’s property value by making home improvements. Updating your kitchen is one of the primary drivers of home value. Adding a bedroom or bathroom or landscaping the backyard can also increase the value of your home. Often, high costs are associated with home improvements, so be sure that your renovation will add real value to your home. If you can’t afford to renovate or don’t need to make improvements, maintain the roof, foundation, and interior of your home to ensure that it doesn’t lose value.
2. Decrease your outstanding mortgage balance
As you pay off your home loan, you are building equity. However, there are financial strategies you can use to pay down your debt and build equity quicker. Reducing your debt and building equity occurs faster with a 15-year home loan than with a 30-year home loan. Interest rates are often slightly lower with a shorter home loan term. While the monthly mortgage payment will be higher, paying interest for 15 years rather than 30 years will enable you to build equity quicker and save money over the term of the mortgage loan. Making just one additional payment each year is another way to build equity quicker. Paying more than the minimum principal payment each month will also help you build equity.
3. Make a larger down payment
The amount of your down payment contributes to the amount of equity you start off having in your home. The higher the down payment, the more equity you have. For example, if you buy a home for $350,000 and make a 5% down payment, you will have $17,5000 in equity. However, if you make a 20% down payment on the same home, you will have $70,000 in equity.
4. Let the market change the value of your home
Home equity is affected positively and negatively by home price changes. In Q1 2022, CoreLogic determined that U.S. homeowners with mortgages (roughly 62% of all properties) saw their equity increase by 32.2% due to home prices increasing since Q1 2021. On the flip side, 2.6% of all mortgage properties saw their equity fall. Fortunately, CoreLogic is forecasting that home prices will increase 5.9% from March 2022 to March 2023, which will help some homeowners who did experience negative equity this past year and further increase the home value and equity of the majority of U.S. homeowners.
Why is building home equity valuable?
As you build equity over time, this valuable asset becomes a financial tool you can use in various ways.
Use your home equity to buy a new home. After living in your home for an extended period, factors such as job location or the need for a bigger space may require you to sell your current home and find a new one. Your home equity is returned to you in cash after covering closing costs and your remaining mortgage balance. You can use this equity to buy another home or use it as a down payment on a new home.
You don’t have to sell your home to access your home equity. You can borrow against it with a home equity loan or a home equity line of credit (HELOC). A home equity loan turns your equity into cash to use and pay back at a fixed rate. A HELOC is a pre-approved amount of money the homeowner can withdraw to pay off high-interest credit cards, medical bills, pay for college or fund any other approved purchase.
Homeowners can use their equity to finance home improvements with a home equity loan or HELOC. You can also refinance your current home loan with a cash-out refinance that enables you to withdraw no more than 80% of your home’s value. Keeping your home up to date and making repairs when necessary can also increase your home’s market value.
Homeowners can use their equity to fund their retirement with a reverse mortgage. A reverse mortgage is a loan that allows homeowners aged 62 years or older to turn their home equity into cash for their retirement. You can pay for living expenses, medical expenses, or in-home care.
Understanding how home equity works is essential to sustain homeownership successfully. The home equity you build can provide financial stability by giving you access to funds in times of need. Be sure to explore your options first and speak with your loan officer or financial advisor to advise you on the right path to take based on your current financial needs and long-term financial goals.