Home equity is the difference between the market value of your home and the amount you owe on your mortgage. Think of it as the part of your home’s value that belongs to you, not the bank. If you were to sell your house today, the equity represents the money you would walk away with after paying off the mortgage.
How to build home equity
There are a few ways you can build equity in your home:
Down payment
Your down payment gives you immediate home equity. For example, if you buy a $400,000 home with a 20% down payment, your equity is $80,000.
If you pay down the mortgage by $20,000 over the next two years and the home's market value stays the same, you'd then have have $85,000 in home equity.
If over those two years the home's market value increased by $100,000, you'd then have $185,000 in home equity.
Pay down your mortgage principal
In the early years of a mortgage, your payment may go only towards interest. You need to pay down your principal (the actual amount you owe) to grow your equity. Over time, as you pay off more of your mortgage, your equity will continue to increase.
Increase in home value
The value of your home can increase for a couple reasons: either the market improves, or you make improvements to the home.
If the real estate market in your area is strong, your home's value might increase, which will increase your equity. Renovations and upgrades can also boost your home's value, contributing to higher equity.
How to take advantage of your home equity
Home equity represents an important financial asset that you can leverage in a few ways:
Home equity loans and lines of credit
You can borrow against your equity in the form of a home equity loan or a home equity line of credit (HELOC). These options allow you to access funds for major expenses like home improvements, education, or emergency costs. However, it’s crucial to borrow responsibly since your home serves as collateral.
Selling your home
When you sell your home, your equity determines how much money you walk away with. After paying off your remaining mortgage balance and any selling costs, the rest is yours. This can be a significant source of funds for purchasing another home or for other financial goals.
Refinancing
If you have substantial equity, you might be able to refinance your mortgage to get a lower interest rate or to switch to a different mortgage term. Refinancing can also allow you to cash out a portion of your equity, giving you access to funds for other purposes.
How to protect and maximize your home equity
To protect and maximize your home equity, consider the following tips:
Keep up with maintenance
Regular maintenance and timely repairs can preserve and even enhance your home's value.
Watch the market
Keep track of the real estate market trends in your area. Understanding market conditions can help you make informed decisions about selling or refinancing.
Borrow responsibly
If you use home equity loans or lines of credit, ensure that you can comfortably manage the repayments since you're using your home as collateral.
Building equity is a powerful way to build wealth whether borrow against your equity, eventually sell your home, or simply enjoying the security it provides.
Sources: Investopedia, Rocket Mortgage, Bankrate
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