Equity is the amount of your home that you actually own, and it is one of the biggest benefits of homeownership. Equity is the difference between your loan balance and the home’s market value. If an appraisal values your home at $175,000 and you are carrying a mortgage balance of $120,000, you have $55,000 in equity.
As long as the market remains stable, equity is like money in the bank. As home values increase and you reduce the amount of mortgage debt with monthly payments, your equity grows.
Ways to Build Home Equity
- Make larger mortgage payments – if you make larger payments each month, a larger portion will go to paying down your principal. In turn, you will pay off your mortgage faster and gain home equity quicker.
- Make (sensible) home improvements – by making home improvements in which the finished value exceeds the cost, you’ll increase your home equity. Improvements that have the best chance of recouping cost at sale include minor kitchen and bathroom remodeling, adding a wooden deck, finishing a basement, energy efficient improvements, etc.
- Make a larger down payment – though it may seem that you’re losing the liquidity of your cash, a larger down payment means a lower loan-to-value ratio, which typically means a lower interest rate. The lower rate will amount to less interest paid and more equity gained.
- Finance a shorter mortgage term – shorter term mortgages mean that you will be paying down principal quicker, therefore gaining additional equity at a faster rate.
The Benefits of Building Equity
Building equity means that you are increasing the net value of your asset. Picture your mortgage payment as a deposit into a savings account. Part of your payment goes toward interest, taxes and insurance, but another part goes toward principal. The principal portion is like putting money in the bank.
As housing markets continue to improve, home equity loans and home equity lines of credit (HELOC) are becoming more common sources of extra cash for homeowners. According to the credit agency, Experian, homeowners took out $111 billion in HELOCs in 2013, compared to $86 billion in 2012.
There are three ways you can borrow from your home’s equity:
- Refinanced mortgages. When you refinance your original mortgage, you are swapping it for another, most likely because the rate of your new mortgage is cheaper. You can also cash out some or all of the equity during your refinance.
- Home equity loan. Also referred to as a “second mortgage”, a home equity loan is when you borrow cash against your equity but leave your original mortgage as-is. A home equity loan is typically used toward consolidating bills, home improvements or large expenses, such as a child’s wedding or college education. You receive a lump sum which you pay back in monthly installments for a fixed rate over a fixed term.
- Home equity line of credit (HELOC). HELOCs are a revolving line of credit, similar to a credit card. You can borrow when needed and you make payments only on the amount you actually borrow, not the full line of credit available. You will be given a credit limit depending on your creditworthiness and the amount of your outstanding debt.
Building equity is one of the easiest ways to grow your financial nest-egg. If you are interested in tapping into your equity, speak with one of our mortgage bankers to determine the best fit for your financial situation.
For more information on borrowing from your equity, refer to our Refinancing Guide.