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Key takeaways:
- There are two ways to build home equity: owe less on your mortgage or own more by improving the value of your home.
- There are some expenses where using your home’s equity may make sense for you.
- You can access the equity in your home with a traditional home equity loan, a home equity line of credit, or a cash-out refinance.
When people talk about home equity, are you sure you know what they mean? And why do they always want to tap into it?
In financial terms, equity is your portion of the ownership of an asset; it’s the difference between what the item is worth and what you owe on it. One of the most valuable assets most of us will ever own is our home, and your ability to build equity is one of the biggest benefits of owning a home.
There are two basic ways you can build home equity. Your home can increase in value so that it’s worth more, or you can pay down your mortgage so that you owe less. And, while equity is typically not usable until your sell the asset, there are things you can do to build equity in your home and then use that equity to pay for other things without having to sell your home.
But first, let’s start with the basics.
What is home equity?
Very simply, home equity is the difference between the current market value of your home and how much you owe on it.
Most people pay their mortgage every month, which means that even if your home’s value remains the same over time, you are increasing your home equity with every payment. In the early years of your mortgage, most of your payment goes towards interest, but over time, more and more goes towards paying down the principal portion of your loan, which reduces the amount you owe and builds your equity. And historically, home prices have usually increased over time, which grows your home equity even more.
However, that equation changes if the value of your home drops. While most people think of home values as always going up, markets can fall as well, which impacts the home equity you have. And if you owe more than a home is worth, you will have negative home equity; it’s called being upside down.
How do I calculate home equity?
First, estimate your home’s value. Remember, this isn’t how much you paid for your home, but rather, what it’s worth today. To get an estimate, talk to a local realtor or use an online service like Zillow. For a more accurate number, you can pay to have an appraisal done; this is really the only way to know for sure.
Next, check to see how much you owe; this is your outstanding mortgage loan balance.
Then, it’s simple math:
Current market value of your home – Outstanding mortgage balance = Home equity
Home equity ÷ Current market value = % Equity in the home
For example, let’s say you buy a house for $250,000 and made a 20 percent down payment, which leaves you with a $200,000 mortgage. Right away, you’ve got $50,000, or 20 percent equity in the home. After a few years, let’s say your home increases in value to $300,000 and you’ve paid the mortgage down to $180,000. At this point, you then have increased your home equity to $120,000, or 40 percent.
Why is it important to build equity in your home?
Building home equity is a long-term financial strategy. It is one of the most common ways to build wealth and one of the best reasons to own a home instead of rent. The amount of equity you have in your home counts towards your total net worth.
With a few historical exceptions, real estate is usually a good investment. Unlike a car, which loses value as soon as you drive it off the lot, property values usually go up over time.
Home equity can also be used to purchase your next home. Let’s say you buy your first home for $200,000; with a 20 percent down payment, that left you with a $180,000 mortgage. You started with $20,000 in home equity. A few years later, you sell the house for $250,000 and you have a mortgage balance of $150,000. This means you have $100,000 in home equity. You improved your equity position from $20,000 to $100,000. Now, if you use that $100,000 for the down payment on your next home, you could buy a $300,000 home and still need just a $200,000 mortgage loan. So, you get more house for not much more in terms of monthly mortgage payment.
How to build home equity
There are basically two ways to build home equity: either owe less by paying down your mortgage or own more by improving the value of your home. Here’s how to do that.
1. Owe less
You have several ways to accomplish this. Make a bigger down payment when you buy the home. Or pay off your mortgage faster, either by paying extra when you make your monthly mortgage payment or by splitting your mortgage payment and making two payments a month instead of just one (called an accelerated payment). Even if you make just an extra one or two hundred dollars payment towards principal each month, it helps you pay down your mortgage and build home equity faster.
2. Own more
The value of your home is determined by several factors. Overall market supply and demand and the selling price of neighboring houses are things you can’t control. However, you can control things like square footage, number of bedrooms and bathrooms, and overall condition of the home inside and out. For example, you can remodel to add on a bedroom or spruce up the kitchen, or you can paint the exterior or improve your landscaping to bump up its curb appeal. The key is to not spend more to renovate than you will gain in home equity.
Ways to use home equity
Your home’s equity can serve as a valuable financial tool. When people talk about ‘tapping into their home’s equity,’ it means they use the equity in their home to do other things. While most experts advise against using home equity to pay for things like a big wedding or vacation, there are some expenses where using your home’s equity may make sense:
- Make home improvements or add on to your existing home (i.e., use your equity to build equity)
- Buy another property—an investment property, a vacation home, or your next new home
- Start a business
- Pay off high-interest credit card debt
- Pay for personal emergencies, such as unexpected medical expenses
- The three most common ways to access your home equity without selling it are:
- A traditional home equity loan
- A home equity line of credit (HELOC)
- Cash-out refinance
These tools typically have lower interest rates than personal loans or credit cards, making them smart alternatives when you need money.
You can also take advantage of your home’s equity to save on taxes. If you use a home equity loan to pay for a home remodel or renovation and you itemize deductions, you may deduct the interest on up to $750,000 of eligible mortgage debt if you use it to ‘buy, build or substantially improve’ the same home that is securing the loan. Tax laws change, though, so always consult your tax professional for details.
How much equity do I need for…
...a home equity loan, line of credit, or cash-out refinance?
At Global, our requirements vary, depending on your credit score and the location and type of property. In general, we require that your loan-to-value ratio (LTV) be 70 to 80 percent or lower before you can apply for a home equity loan, line of credit, or cash-out refinance. This means you need at least 20 to 30 percent equity in your home to qualify.
For example, if you have an 80 percent maximum LTV requirement and your home is worth $300,000, your mortgage balance must be $240,000 or less to qualify ($300,000 x 0.80 = $240,000).
The amount you can borrow is also dependent on your home equity position.
Let’s say your home is valued at $300,000 and your mortgage balance is $200,000. This means you could be eligible to borrow up to $40,000 ($300,000 x 0.8 = $240,000 - $200,000 = $40,000).
How quickly can you build equity in your home?
Time is an important part of the home equity equation. The longer you stay in your home, the more likely you are to build equity because home values generally increase over time, and you steadily pay off your mortgage loan over time. And, as you make mortgage payments through the years, the portion of your payment that goes towards paying down the principal goes up. This means the longer you pay on your mortgage, the faster you’ll build home equity.
But there are other things you can do if you want to speed up your home equity growth:
- Pay extra toward your principal each month. Just be sure to have that extra payment go towards your principal and not the interest.
- Refinance to a shorter mortgage—a 15-year instead of a 30-year mortgage, for example. You’ll pay off the loan in half the time.
- Make improvements that increase the value of your home. Remodel a kitchen, add on a bedroom or bath, or make other changes. But keep in mind that the cost of the improvements you make rarely has a direct correlation with value. For example, if you spend $25,000 to remodel your kitchen, you cannot expect the value of your home to increase by $25,000.
A hot housing market can also help you build equity, but this is something beyond your control. And markets can be fickle; if property values in your area drop, this will decrease your home equity.
How we can help you build and manage home equity
Your home’s equity is an important part of your financial net worth. We can help you on both sides of the home equity equation—to own more and owe less.
- The Global Real Estate Lending department offers competitive rates on home equity loans and home equity lines of credit. You can use the money to improve your home and its market value. Contact us today.
- Global Credit Union Home Loans has flexible mortgage loan terms that allow you to pay extra each month or make multiple payments every month so that you can pay down your existing mortgage faster. Contact our mortgage company today.
- Global Credit Union Home Loans can also help you refinance to a mortgage with a shorter term—switching from a 30-year to a 15-year loan for example—or tap into your equity with a cash-out refinance.
- Turn to us if you have an unexpected need for cash. We can help you weigh your options so that you can decide if a personal loan or a home equity loan makes the most sense for you.
Your home’s equity gives you a place to turn if you ever need money. At the same time, your home’s equity also gives you a place where you can build wealth. Building equity takes time, but patience will pay off. We’re here to help you through this process.
