Building equity is one of the primary benefits of buying a home. Home equity can enable you to finance a renovation, pay off debt, or even launch a small business. When you factor in today’s low interest rates, the possibilities are even more interesting.
While home equity is a readily available resource for many families, some are afraid to use it because they don’t understand the benefits and consequences. If you’re unfamiliar with the ins and outs of home equity, don’t worry! In this article, we’ll explain everything you need to know to make an informed decision.
What Is Home Equity?
Equity is the difference between the remaining balance on your mortgage and your home’s current value. If you purchase a home for $300,000 with a 20% downpayment, you start with $60,000 in home equity.
How Do You Get Home Equity?
You build home equity over time in two ways. First, your equity increases as you pay down your mortgage principal. For example, if you purchased that $300,000 home five years ago with a 20% down payment and a 5% interest rate, over your first 60 months, you paid about $20,000 toward the principal and $57,000 in interest, leaving a balance of $220,000 on your mortgage. If your home’s value had not changed, you would now have $80,000 in equity.
But home values do change. This is the second way you build home equity over time. Home values tend to rise based on market demand and other economic factors. Home values may not change a lot each year, but even small changes are significant over time. For example, if your $300,000 home increased in value by just 3% each year, it would be worth more than $347,000 after five years! If you paid your mortgage as described in our first example, you would now have $127,000 in equity!
What Else Can I Do To Increase Home Equity?
The most obvious way to establish more equity in your home is with a large down payment when you purchase, but this isn’t always an option.
Another strategy for building equity is paying a little more than your minimum mortgage payment each month. By paying just $100 extra per month on the $240,000 example in this post, you would pay off the 30-year mortgage in just 25 years and 7 months. After only 60 months, you would have paid an additional $6,000 on your mortgage, but you would have increased your home equity by $6,800. Why is this number higher than the amount of your additional payments? You are paying down the balance owed, and this means a larger portion of every payment goes to principal rather than interest.
You can also build equity by renovating. Adding extra space and other improvements can increase your home’s value and curb appeal. This can be complicated if you refinance or take out a second mortgage to pay for the renovations, so let’s take a closer look at options for tapping into your home’s equity.
How Do You Tap Into Home Equity?
Borrowing money against your home equity can be beneficial, because the interest rates are lower than typical rates on personal loans or credit cards. You earn this lower rate by using your house to secure the loan.
There are three common options for borrowing against your home’s equity:
- A home equity loan
- A home equity line of credit
- Cash-out refinance
Home Equity Loans are also known as second mortgages. You can secure a loan for about 85% of the value of your equity in your home. Just like a primary mortgage loan, it is paid back in monthly installments.
Home Equity Lines of Credit (also known as a HELOCs) are similar to credit cards, but your credit limit is determined by your equity in your home. You make regular payments on the amount you borrow, even if it’s less than the amount you qualify for.
Cash-Out Refinances involve a new loan with an updated interest rate and loan term. If you take out a new mortgage for more than you owe on your current loan, taxes, and insurance, you can receive a lump sum payment for the difference, and you are free to do anything you like with these funds. This can be especially beneficial during times when interest rates are very low.
Learn more about how and when you should refinance your home on our blog!
Get the Support You Need
At MortgageRight, we help home buyers and current homeowners like you find the mortgage loan that’s both a perfect fit for your individual needs AND at terrifically low interest rates! You can get the best deal to start building your home equity today, getting you steps closer to the big purchase you’ve been saving for!
