What Is Home Equity And How Does It Benefit You?

The word “equity” is usually associated with entrepreneurship or the stock market, but home equity isn’t all that different. The same way someone might buy stocks or invest in a startup to achieve financial gain, homeowners can build up home equity to increase their wealth. 

Understanding what home equity is, how it works and how it benefits you can help you achieve financial success. Let’s take a closer look at how to make the most of your home’s equity. 

What Is Home Equity? 

Home equity is the percentage of your home that you “own” – the portion that you still owe on your mortgage isn’t yours until you pay more of it down. In other words, home equity is the difference between what’s owed on a mortgage and the value of the home. 

Home equity rises and falls depending on different factors, like your remaining balance and the conditions of the real estate market. As home value goes up, so too can your home equity – and vice versa. Typically, though, the more you pay toward the mortgage, the more home equity you have. 

Why Is Building Equity Important? 

Building home equity increases the amount of money you have in a property. And therefore, the amount of money you may be able to use now or down the road. 

There are a few different ways to tap into your home equity, like through a home equity loan or a home equity line of credit (HELOC) (more on this later). And unlike other assets, such as a car, your home has the potential to appreciate in value over time – meaning it may be possible to sell your home for a profit or increase your net worth. 

How Does Equity In A Home Work?

Home equity is not a liquid asset. You can’t take money out the same way you would with a savings or brokerage account. Instead, think of home equity like a long-term strategy toward boosting your net worth. Your home equity will go up as you make payments on your mortgage and reduce your loan’s principal balance. 

How To Calculate Your Home Equity

Home equity is usually expressed as a percentage and refers to the amount of your home that you actually own. To calculate home equity, take your outstanding mortgage principal, or what you still have to pay on your mortgage, and subtract it from the home’s current value. 

Let’s see an example. Imagine you want to buy a home that is currently valued at $300,000. You pay $45,000 down at the time of purchase – a 15% down payment. This 15% translates into home equity at the time of closing. 

For the sake of this example, let’s assume your home’s value has not changed and 10 years later, you now owe $200,000 on your mortgage. Here’s how you would calculate your new home equity in this scenario: 

$300,000 - $200,000 = $100,000

This means you have $100,000 in home equity. Here’s how to calculate that figure as a percentage: 

$100,000 / $300,000 = 0.33 or 33% home equity

Realistically, your home’s value is bound to change over time. But this can be to your advantage. Let’s imagine that 10 years later, your home appreciates in value and is now worth $350,000. Keeping everything else unchanged, here’s what your new home equity would look like:

$350,000 - $200,000 = $150,000

$150,000 / $350,000 = 0.428 or 42.8% home equity

In basic terms, your home equity grows alongside your home’s sale value. The percent you have in home equity will be worth more as home value increases or the market shifts.

5 Ways To Build Equity In A Home

Building assets in the form of home equity may be able to increase your net worth or how much money you can invest back into your home. Let’s look at some different ways to build home equity. 

1. Increase Your Down Payment 

Since larger down payments mean owing less on your mortgage from the start, increasing your down payment amount is a good way to build home equity right off the bat. And when it comes to conventional mortgages, having a 20% down payment can help eliminate the need for private mortgage insurance (PMI), which can cost 0.1% – 2% of your loan amount per year. Rocket Money^SM can help you save for your home automatically based on your spending habits, and stay on top of your money to improve your finances.

2. Make Larger Monthly Mortgage Payments 

The key to building equity is making payments toward that principal loan amount – what you actually owe on your mortgage, not insurance or interest. Therefore, making larger mortgage payments or biweekly payments can help you build equity faster. If you have a different type of loan, like a non-amortizing loan, you may need to make extra payments to boost home equity. 

But being able to make larger or more frequent mortgage payments is easier said than done. We recommend taking a look at your budget for areas you can cut back on or put on hold for the time being. You might also consider picking up a side hustle if you’re able to bring in additional income. You can easily set up a budget and even create custom spending categories using Rocket Money.

3. Remodel Or Renovate Your Home 

Like we explored earlier, your home equity is directly linked to your home value. It’s true that in some cases you may be able to build equity purely based on market conditions – if your area’s real estate market is strong, your home value may go up with little to no change to your mortgage. 

That said, if you want to increase the chances of upping your home’s value, you might consider remodeling or renovating your home. In doing so, be sure to do your research or consult with a real estate agent or realtor that can help you figure out which home improvement projects would actually increase home value and how you can go about them in your home.  

Generally speaking, adding curb appeal or kitchen and main bathroom remodels are great ways to give your home’s value a boost. Smaller upgrades like door or window replacements also tend to have a reliable return-on-investment (ROI). 

4. Stay In Your Home At Least 5 Years 

The longer you stay in your home, the more time you have to amass home equity. While this is still dependent on how much money you put toward the mortgage principal, staying in one place long-term can come with financial benefits. 

So, why 5 years? New homeowners are usually advised to stay put at least for the first 5 years of owning their home. This is to avoid losing money or breaking even on your home purchase, which can happen after taking things like closing costs and real estate commissions into account. Because of how mortgages work, it also takes time to begin paying a significant portion of your principal, as the majority of your first years’ payments will go towards interest. This means it’s in your best interest to stay a few years, to pay your mortgage down and increase your equity.

5. Refinance Your Mortgage

In some cases, refinancing a mortgage can also build equity. While you’ll still owe the same principal balance, refinancing may be able to help you own more of your home – and faster. 

If, for instance, you refinance to the same mortgage term but with a lower interest rate, you can use money you’d otherwise be putting toward interest toward your mortgage principal instead. Another way refinancing might help is if you choose to shorten your loan term. Even if you don’t make extra payments, you’ll be paying your mortgage off sooner than with your previous home loan. 

Keep in mind, however, that shortening your loan term will increase your monthly payments. Only take this on if you can confidently afford to make these new, higher monthly payments. 

How To Use Home Equity 

Once you’ve built up significant equity – usually around 20% or more – there are several ways to use it. Whether it be in partial amounts or by taking out a lump-sum, let’s explore the options you have when accessing your home equity: 

Cash-Out Refinance 

A cash-out refinance allows you to swap out your existing mortgage for one in a larger amount and receive the difference in cash. The newly borrowed amount will have to be paid back with interest, but the cash can be used for most anything. Many homeowners put it toward home renovations or remodels. 

Home Equity Loan 

A home equity loan is like a second mortgage, where you keep your existing mortgage and borrow up to a certain amount of your existing home equity. This money is then dispersed as a lump sum – and similar to a cash-out refinance, you can use the money for most any purpose. 

A home equity loan is usually a fixed-rate loan and it can be paid back through different repayment terms which vary by lender. 

Home Equity Line Of Credit (HELOC) 

Similar to home equity loans, a home equity line of credit is based on a percentage of your home equity. But unlike home equity loans, HELOCs function like a line of credit. Once approved, you’ll receive a credit limit that you can borrow up to. Keep in mind, some lenders may have minimum amounts you must take out. 

During what’s known as the draw period, you can pay back the loan and borrow more. Draw periods can last anywhere between 5 and 20 years, and during this time you’re making interest-only payments. Once the draw period has ended, the repayment period starts and you’ll begin making payments toward the interest and principal amount.

Should I Borrow Against My Home’s Equity? 

Whether you choose a HELOC, a loan or decide to refinance, whether borrowing against your home’s equity is right for you depends on your unique circumstances. To paint a clearer picture, here are some instances of when it’s best to tap into that equity, and situations when it’s not. 

When It’s A Good Idea 

Home equity loans are usually best for borrowers with steady, reliable sources of income who know they will be able to repay the loan. It also works best for homeowners with home improvement projects or specific financial goals in mind. You should know how much you need to borrow and how you want to use it. 

When It’s Not A Good Idea

Home equity is not a good long-term solution for managing debt. It can be tempting to take out more than you really need or to take out a loan worth more than your home, but doing so can send you even deeper into debt down the road. You’ll still need to repay your loan with interest, and payments for any portion of a home equity loan above your home’s value are not tax deductible. 

When It’s Up For Debate

Home equity is good to have, but sometimes tapping into it can reap even bigger rewards by upping your home’s value. But the housing market can be unpredictable, meaning that if and when borrowing against your equity is the right choice depends largely on your risk tolerance and external factors. Be sure to do your research, understand what your budget can allow for and consider speaking with a professional before making any big decisions. 

The Bottom Line 

Building wealth with home equity is a long-term endeavor that can pay off if you’re strategic about it and consistently make your monthly payments. Home equity loans, HELOCs and cash-out refinances are the options available to qualifying homeowners looking to build up equity or add value to their home. 

If you feel ready to take the next step, get started with Rocket Mortgage®.