As it relates to your home, equity can be defined as the difference between what you owe on your mortgage and the fair market value of your home. The possibility of growth in equity—and the accompanying growth in your own personal wealth—is one of the enormous benefits of becoming a homeowner. You gain equity simply by making your monthly payments on time, and you can borrow on the equity in your home (through a cash-out refinance) to help pay for major life expenses. How much equity—and how quickly you gain it—depends on several factors.
Down Payment
It is possible to gain equity in your home even before the movers arrive with your belongings. By means of the down payment you make on the purchase of your home, you immediately acquire equity by lowering the loan-to-value ratio (often called the LTV). If the fair market value and purchase price of your home is $180,000 and your down payment is 20%, you have attained $36,000 of equity—right at the outset!
Home Appreciation
Home values can rise or decline in response to market conditions, such as the economy, mortgage rates, supply and demand and so on. In a housing market with increasing home values, you will gain equity by simply sitting back and waiting. Any increase in equity presupposes that you keep your home well maintained and that you make your monthly payments on time.
Increasing Home Value
Working proactively to increase your home’s value via home improvements can also increase your equity. However, not all home improvement projects are created equal nor guaranteed to get a return on your investment. Some projects which typically increase home value—with an increase in equity for the owner—include the following:
- Kitchen and bath remodels
- Creating a wide, open floor plan
- Adding space
- Updating the home
Routine Home Maintenance
While replacing gutters, tuning up (even updating) the heating and air conditioning system or adding extra insulation to the attic may not be on the top of most homeowners’ lists for home projects, they are nevertheless among those items which will increase value when it comes to selling a home. Keeping up to date on home maintenance not only enables a home to function properly, making certain these repairs are carried out increases value and, again, equity.
Speeding up Equity
Some homeowners choose to accelerate the increase of the equity they have in their home with pre-payment strategies on their mortgage or through reduction of the term (length of time) of their mortgage.
By adding an additional amount to monthly principal payments or making an additional lump sum payment (over and above the required monthly payments), homeowners can gain thousands of dollars in equity.
By shortening the loan term, the pace of growth can also be increased. While a 15-year, fixed-rate mortgage requires larger monthly payments, this shorter term typically comes with a lower interest rate than a 30-year, fixed-rate loan and allows the borrower to pay appreciably less interest over time.
If tapping into your home equity is one of your mortgage goals, check out our Refinancing Guide for information on the types of refinancing available, the cost of refinancing and the best timing for refinancing.