So - you and your family have purchased a house recently and now you have a new financial asset to take advantage of - it’s called home equity.
If you’re a newer homebuyer, you probably haven’t built up too much home equity yet - unless you’ve made a massive down payment.
However, with the insane housing market this year, median home values have increased by $31,000 on average. That’s not a small number! Home equity is a valuable asset, and as your own home equity continues to grow, it’s important to know what you can do with it, and how to build it more quickly.
So, in this article we will explain the basics of home equity and how you can begin building it in your family home.
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What is Home Equity?
To start, let’s define home equity. Homeowners build home equity with every mortgage payment they make each month - not including interest on your loan.
Home equity grows over time. It essentially represents how much of your home you own, or how much you have paid off.
You may convert home equity into cash when unexpected or large expenses arise by using a home equity loan or a home equity line of credit.
It’s good to know how much equity you have because lenders set borrowing amounts based on this. Generally, the more equity you have, the more you can borrow.
How to Calculate Home Equity
So, how do you know how much home equity you have? Equity is calculated by subtracting your mortgage balance from the home’s current market value.
So, let’s say you purchased your home two years ago for $500,000. Let’s assume your home has appreciated by 4% each year, and that you made a 10% down payment of $50,000, and you’ve been making monthly payments since then (for 24 months total).
How much home equity do you have?
Here’s the calculation:
Current home value - mortgage balance
($540,800 - $426,705) = $114,095
To help do calculations for your own finances, you can Google “Home Equity Calculator” and “Amortization Calculator.”
Each year as your home appreciates and you pay off your mortgage, your home equity should increase - unless you decide to take out some sort of home equity loan.
How to Increase Your Home Equity
If you’re looking to utilize your home equity and take out a home equity loan or line of credit, you may be wondering how you can increase your equity faster and borrow more.
Home equity loans and lines of credit are attractive financing options because they often offer lower interest rates than personal loans. Whether it’s school tuition, medical bills or renovation costs, homeowners take out home equity loans all the time.
However, you will be limited to roughly 90% of your current home value (minus outstanding mortgage balance).
Here are some of the top ways you can increase your home equity:
Pay More on Your Mortgage
You can build equity quicker when you decrease the total you owe quicker. In other words, try to pay more than the minimum. This is easier said than done, but there are lots of ways to motivate yourself to make payments more quickly than the minimum amount you owe each month.
Some of the top methods to consider:
- Make extra payments towards the principal every month. Ensure with your lender that your payment will go towards the principal and not the interest.
- Consider switching to biweekly mortgage payments, rather than once at the end of the month, which can help shorten your loan term.
- Couples sometimes live on one salary while committing the other person’s paychecks to paying down the mortgage.
- Consider renting part of your property to put your tenants’ rent money towards paying off your mortgage.
- If you receive a tax refund, gift or work bonus, consider putting it towards your mortgage balance. You may even simply want to revisit your budget.
- If one of the above options is unavailable, consider making at least one more payment per year.
Increase the Property Value
If making more payments toward your mortgage balance isn’t a viable option for you, another way to build equity is to increase your property’s value by making improvements to your home.
Making home improvements can boost your property value and equity. But, you likely won’t recoup all the money you put into home projects.
There are a ton of different ways to do this, but here are some of our top suggestions:
- Consult with a professional to see which types of home projects yield the biggest return.
- Stick with smaller projects you can pay in cash, like painting walls, updating light fixtures, or replacing a garage door.
- Increasing curb appeal also helps.
- Give your grass a fresh cut, install shutters, and add flowers to help improve your home’s value once it’s time to sell.
- Perform routine maintenance.
- Keep on top of leaks, roofing issues, and general home maintenance.
- Consider a RenoFi Home Renovation Loan for larger home remodeling projects.
Make A Big Down Payment
If you’re yet to purchase a home, consider making a larger down payment. While some mortgage loans require 3.5% or less of the overall home price in the form of a down payment, that doesn’t mean you have to stick with the minimum.
Saving up for a larger down payment is a great way to start your home ownership journey with more equity. Putting down more money will instantly boost your equity.
However, you shouldn’t make so big a down payment that you have no savings buffer left. Consider how much savings you’ll have left after closing. You still want to have enough for your monthly payments.
Experts recommend a 20% down payment if you’re looking to build up quickly.
Wait for Your Home Value to Rise
Last but not least, if you’re not in a rush, you can be patient and wait. If you continue to make payments on time, your equity will rise (unless there’s an unforeseen housing crash). When home prices drop, you may lose some equity.
You don’t have much control over this, but it’s still good to keep in mind. You can check your home’s value by using an online tool or consulting an appraiser.
Your home value rises when prices in the neighborhood and there is more demand. This boosts the amount of equity you have. You’ll increase your odds of an equity boost if you stay in your residence for at least 5 years.
How to Use Home Equity
Equity is important because it’s considered an asset, and you can use it to help finance many things.
Here are some of the most common uses for home equity:
- Save up for a future down payment on your next home. With a larger down payment, you can get into a more expensive home because your mortgage & monthly payment will be lower.
- Save for the price of a college tuition.
- Save for a larger kitchen or bathroom remodel in your home.
- Supplement your retirement savings.
- Pay off high interest rate credit cards, which may also help boost your credit score.
How Can I Borrow Against My Home Equity?
- Home equity loan: Home equity loans allow you to take out a portion of your home equity all at once in a single lump sum. Most home equity loans allow you to pay back this total over a term of 10-20 years with a low interest rate depending on your credit score. You’ll most likely be limited to 90% of your total equity.
- Home equity line of credit: A home equity line of credit is basically a credit card that will be drawn from your home equity. You’ll have a draw period, when you can draw from your equity, up to a certain limit, and after this time, you’ll begin to start paying back whatever equity you ended up taking. Often these lines of credit, also called HELOCs, will have variable interest rates.
- Cash-out refinance: Cash-out refinances are a great option for homeowners looking to refinance their mortgage loan into a lower interest rate. Because they do have closing costs, experts recommend refinancing only if rates have dropped at least 1% more than what you’re already paying. When you refinance, you can take out a certain amount of money from your equity - and it won’t be a loan - the money you now owe will just be added to your new mortgage.
- RenoFi Loan: RenoFi Loans are a new type of home equity loan option that allows you to use your home equity to finance renovations - but your borrowing power is based on your home’s after renovation value, rather than the current value. This factor allows homeowners to borrow 11x more on average than traditional home equity loans.
How RenoFi Helps You Build Home Equity
For new homeowners that want to renovate their home, home equity loans are often out of reach for years - which is why we’ve created RenoFi Loans.
Just looking at the example below, these homeowners won’t be able to take advantage of their home equity to fund a major remodel for an entire decade.
Right now, most homes on the market are older - which means even if homeowners aren’t looking to make aesthetic changes, their homes will still need updates.
RenoFi Loans allow “equity-light” homeowners to not only utilize their home equity sooner and borrow more, but also make changes through renovating that will increase their home’s value.
Just check out Justin and Nikki’s story. They used a RenoFi Loan to double their home’s value.