How to build equity in your home in 10 steps
Is your home one of your biggest assets? For many Americans, the answer is yes. If this is true for you, you might be concerned with how to protect your home’s equity and grow its value as part of your overall financial plan.
But even if you have positive home equity, that doesn’t mean you should get complacent about it. “Equity reduction can come when you least expect it,” says Rob Cook, vice president of marketing and customer experience for Discover® Home Loans. “Even slight economic or real estate fluctuations could reduce home prices, and you want to be in a good equity position if that happens.”
What is home equity?
Home equity refers to the difference between your home’s current market value and the outstanding balance on any mortgages secured by your property. It represents the portion of your property that you own outright. For example, if your home is worth $350,000 and the balance on your mortgage is $250,000, your home equity is worth $100,000.
As you continue to make mortgage payments and your home’s value increases, you build more equity.
Why is important to build equity in your home?
Building equity in your home is not just a matter of pride in homeownership—it also brings potential financial benefits. Here are some of the key reasons why you might want to grow your home equity:
- Wealth creation: Investing in a home often comes to represent the most substantial part of your overall wealth. When you repay your mortgage and watch your home value increase, you’re sustaining a financial resource that appreciates over time and contributes to a strategy for creating wealth.
- Improved borrowing capacity: Equity in your home can act as collateral that allows you to qualify for home equity loans or lines of credit. Whether you need to finance home renovations, consolidate high-interest debt, or refinance an existing loan, your home equity can provide the borrowing resource you need for taking out a single loan to use in almost any way you like.
- Funding major expenses: Home equity can be a source of funds for large expenses such as college education costs, medical bills, or planning a wedding. It opens up the possibility of using a home equity loan or line of credit to meet these expenses, often at lower interest rates than other types of loans.
- Boosted financial security: Building equity may provide a cushion in times of financial hardships. In scenarios like this, you could consider selling your home to access the equity or borrowing against it.
- Retirement planning: For many homeowners, home equity likely forms a core part of their retirement planning. You might choose to downsize by selling your home once the mortgage has been fully paid and receive the funds from the sale in a lump sum for retirement.
- Estate planning: Building equity in your home has the potential to play a significant role in your estate planning. If you plan to pass your home on to your heirs, they may benefit from the value of the equity that has appreciated over time.
Home equity may provide a source of financial stability and flexibility. It is typically an asset that can be leveraged in various ways throughout the time you own your home to open up opportunities for future financial growth.
10 steps to build your home equity
You will want to use your home equity responsibly, as it is a valuable asset that may help you secure your future. By following these ten steps and making informed decisions, you could be well on your way to building a solid equity foundation in your home.
Your down payment
When you first purchase your home, the more money you contribute towards a down payment, the more equity you have from the start. If possible, consider putting more than 20% of the sale down as a down payment and free up equity to borrow from in case you need to make unforeseen upgrades soon after purchasing a new house. If you want to borrow from a home equity lender that requires a combined-loan-to-value ratio (CLTV) under 90%, you’ll need to have more than 10% equity available to borrow from—and the amount up to 90% must be within the lender’s loan limits. CLTV is the total amount of your mortgage and any loan you want to take out against your home equity, divided by your home value.
For example, if your home cost $400,000 and you made a $40,000 down payment, you would need to take out a mortgage for $360,000 and your CLTV would already be 90% at the time of the sale.
But if you put a 30% down payment into a $400,000 house, you would have a 70% CLTV and $120,000 of equity built up right away. If the price of your home remained at $400,000 and you wanted to take out a home equity loan the year after you bought it, you could potentially borrow up to $80,000 bringing your CLTV up to 90%.
In summary, a larger down payment up front may give you more flexibility in the future.
Your principal mortgage balance
One of the easiest ways to grow home equity is to simply stay in your home and make regular payments on your mortgage. The goal is to reduce the principal you owe on your loan. Over time, as you pay down your mortgage and the value of your home increases, your equity will rise.
While your home’s value will fluctuate over time (and could even go down certain years), the money that you pay toward your mortgage will put your equity on a path to grow over the long term.
Shorter loan term
By choosing a shorter loan term for your mortgage—such as a 15-year term instead of a 30-year term—you can pay off your loan and build more equity sooner.
Extra mortgage payments
If you can afford it, make additional principal payments on your mortgage. You could do this by contributing an additional percentage to your monthly payments, or by making lump sum payments throughout the year. Consider contributing money you receive from bonuses at work or as a gift to your mortgage as an extra payment. This reduces the loan balance and accelerates the equity-building process.
As an example, a principal balance of $360,000 on a 30-year mortgage at an 8.50% interest rate will have a monthly payment of $2,768.09. If you make minimum monthly payments for 30 years, the total amount you will pay in principal and interest will be $996,511.87.
If you make just one extra payment of $2,768.09 in the first year of that mortgage, the total amount you will pay in principal and interest over the life of the loan will be $965,746.22. In this scenario, you could save about $30,765 by making that one extra payment!
Home improvements and renovations
When you make changes to, repair, maintain or improve your home, think about whether they’ll add value for a future buyer, even if you’re not planning on selling any time soon. While it’s rare for home renovations to generate an immediate dollar-for-dollar return on investment, they can help improve the value of your home over time and make it easier to sell or refinance. If you don’t know where to start, think about focusing on projects in high traffic areas of the home such as your kitchen or bathroom, or making energy-efficient upgrades that save money on utility bills.
Maintain your home consistently, addressing minor issues before they become major problems. A well-maintained property may retain, and ideally, increase its value over time.
Refinance to a lower rate
If current market conditions are favorable, you can refinance your mortgage to a lower interest rate, which may reduce your monthly payments and allow you to build equity more quickly. Even if you can refinance to lower your interest rate by half a percentage point, the savings might be worth it.
Consider this: You take out a mortgage for $250,000 for a 30-year term at 8.0%. Your monthly payment would be $1,834.41. A loan for the same amount and same term at 7.50% would have a monthly payment of $1,748.04. That’s adds up to a difference of over $1,000 per year.
The best refinance rate depends on finding what you’re eligible for and what works for your financial goals.
When you have equity built up that you want to borrow from and you’re looking to refinance, a cash out refinance may give you a unique opportunity to take care of both with a single loan.
Monitor the local real estate market
Keep a close eye on the market trends in your neighborhood and consider selling your home if you expect your property value to peak. With the funds from the sale, you may want to invest in a new home in an area where property values are on the rise to begin growing equity again.
Tap into your equity responsibly
Resist the urge to borrow from your equity for non-essential purposes. Instead, focus on building equity to use it towards financial goals later, such as retirement or a child’s education. Whenever you are considering taking out money from your home equity, it’s a good idea to weigh the pros and cons of using a home equity loan or line of credit to decide what will work best for your unique goals.
Remember that building home equity is a long-term process that requires patience and some financial discipline to achieve.
How long does it take to build equity in your home?
The length of time it takes to build equity in your home varies depending on factors such as the size of your down payment, the interest rate on your mortgage, your loan term, your home’s appreciation in value, and your financial habits. In general, it may take several years of consistent mortgage payments and market appreciation for a high level or equity accumulation.
Ways to use your home equity
Once you have enough equity built up in your home, you may consider using it strategically for various purposes. A few examples include:
- Home improvements: Use your equity to invest in renovations that increase your home’s value, provide a high return on investment, or simply improve the quality of your living spaces for you to enjoy.
- Debt consolidation: Tap into your home equity to pay off high-interest debts. Borrowing a debt consolidation loan from your home equity can combine multiple debts into a single payment and potentially give you a lower, fixed interest rate.
- Education expenses: Use equity to fund higher education for yourself or your children.
- Emergency fund: Your home equity may serve as an emergency resource in times of financial, personal, or medical crises.