What Is Home Equity?
In the real estate industry, we talk about “home equity” all the time. It’s an important concept—and it’s an even more important tool for homeowners. But what is it? And why does home equity matter? Well, in simplest terms, your home equity is the dollar amount you actually own in your home.
But, of course, home equity is much more complicated than that, so let’s break it down even further.
Today, we’ll discuss:
Understanding Home Equity
There are two big factors that impact your equity:
Your home’s current market value.
The amount you’ve paid on the mortgage so far.
The current market value is a powerful force in terms of equity—but so are your monthly mortgage payments. If you buy a $100,000 home with a $20,000 down payment, you’d immediately have $20,000 equity in your home.
Now let’s say you have a $500/month mortgage and you pay it faithfully for a full year. You’d have $26,000 in equity at the end of the year (because you’d have paid $500 every month for 12 months).
But what happens if a major Amazon plant pops up down the road from your home, and numerous restaurants and stores appear nearby to serve the sudden increase in traffic? That new economic activity in your region could create more demand for housing in your neighborhood—which could then increase your home’s value
Let’s say your home then increases in value from $100,000 to $150,000 over that same 12-month period. Your equity would actually move from $26,000 to $76,000, as your equity increases with the value of your home!
Why Equity Matters
At a glance, equity shows how much you’ve paid off and how much you own in your home. But equity can also become a tool you can leverage in your favor. As we’ll discuss later, you can use your equity for tools like:
Home Equity Loan - Also called a second mortgage, you’re borrowing against your equity, usually for big payments like home repairs or college tuition.
Home Equity Line of Credit - A HELOC loan is a line of credit for large expenses.
Cash-Out Refinance - With a cash-out refinance, you can turn some of your equity into cash!
Bottom line: Equity matters because it is a wealth-building tool that can be leveraged for other investments.
How to Calculate Your Home Equity
Calculating your home equity is relatively straightforward, and you can use this formula:
Current Home Value - Mortgage Balance = Home Equity
Let’s put this into practice.
Say your home is appraised at $250,000 and you owe $100,000 on your mortgage. $250,000 minus $100,000 is $150,000, so you’d have $150,000 in equity!
Remember: Your equity can shift with the latest market trends. If the value of your home suddenly decreases, your equity could decrease with it.
How to Increase Your Home Equity
There are a number of strategies you can use to increase your home equity. Those include:
1. Make a large down payment when you purchase your home. There are numerous pros and cons to making a large down payment (think 20% or more). The most obvious that comes to mind for most buyers is eliminating mortgage insurance.
Another major benefit is simply getting more equity—faster. If a mortgage requires a 5% down payment, you walk away from the closing table owning 5% of your home outright. But if you put down 25%, you walk away with 25% equity of your home’s value.
Take note: Talk to your financial advisor or a neutral third party who understands your situation before committing to a large down payment. Depending on where you are in life and your short- and long-term financial goals, it may be more beneficial to use a modest down payment and keep the rest of your money in other investment vehicles.
2. Continue paying your mortgage every month—and pay as much as possible. If you can, work to pay off your mortgage faster. The more money you pour into your mortgage each month, the faster your equity increases.
3. Attack the principal. Yes, making large payments every month can certainly help increase your home equity, but you also need to make sure those payments are attacking the principal (and not just the interest on that mortgage).
4. Make judicious updates. Not every project is going to significantly increase your home’s value (and your equity)—or give you an immediate ROI. If you’re thinking about a remodel or an addition to boost your home value, talk to a real estate professional beforehand. In addition, remember: You’ll typically see the best ROI on projects focused on high-traffic areas (think of the kitchen and the bathroom) and from projects that increase your home’s square footage (like adding an in-law suite or guest bedroom).
If you’d like to learn more about building equity, look for our next blog, How to Build Equity In A Home, or contact us!
