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What Is Home Equity And How Does It Benefit You?

Sarah Li Cain4-minute read
February 03, 2022

Homeowners can build wealth through home equity, especially as they pay down their mortgage or as their home’s value increases.

But what is home equity? Think of it as your vested interest in a property – the more you put in, the more you get out. Home equity can be one of your largest and most valuable assets. If you’re strategic about it, you can use this asset later on to your advantage.

Let’s take a closer look at exactly what it is, how it works, and how it benefits homeowners.

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What Is Home Equity?

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

Home equity can rise and fall depending on factors such as the amount you pay down on your mortgage and the current real estate market. As your home value goes up, your home equity may go up, and vice versa. Or, the more you pay toward the mortgage, the more home equity you have.

How Does Home Equity Work?

Home equity is an asset you can tap into using a few methods (more on this later). However, it’s not a liquid asset like what you have with a regular savings account or a taxable brokerage account, where you can access cash relatively quickly.

Instead, think of home equity as a long-term strategy of building your net worth. And unlike other types of other assets (like your vehicle), your home has the potential to appreciate in value, though that’s not guaranteed.

Your home equity is typically expressed as a percentage of the home you own, though you can refer to it as the amount you have in your home.

To calculate home equity, take the current value of your home and subtract it from what you still owe on your mortgage. Then, divide that amount from your home’s current value.

For example, your home is currently valued at $450,000 and you put down a 15% payment. In this case, you have $67,500, or 15% of home equity. However, if you’ve been paying down the home for 10 years and you only owe $150,000 on your mortgage, you have $300,000 of home equity — assuming the home is still valued at $450,000. Dividing the amount you have in the home by the home value, you have 66% in home equity.

How To Build Equity In A Home

Building assets in the form of home equity can help increase your net worth. There are several ways you can build home equity, including paying down your mortgage and increasing the value of your home.

Increase Your Down Payment

Increasing your down payment helps build equity because you’re starting off your homeownership journey by having more money in your home. You’ll owe less on your mortgage at the start.

Plus, putting down a larger down payment for conventional mortgages can help eliminate private mortgage insurance (PMI). You’ll need to put down at least 20% down, and could save you from having to pay PMI. If you’re taking out government-backed mortgages like FHA loans, you’ll need to pay mortgage insurance no matter your down payment amount, but you can still build your home equity more quickly by increasing your down payment.

Make Larger Mortgage Payments

Making larger mortgage payments or biweekly payments helps build equity because you’re putting more toward your loan principal faster. That means the faster you pay down your mortgage, the sooner you’ll own more of your home outright. If you have a different type of loan (such as a non-amortizing loan) you may need to make extra payments to increase home equity.

To help you pay down your mortgage faster, you can consider adjusting your budget so you can make larger payments. Look through your spending to see if there are any areas you can cut back or eliminate altogether and use that amount toward your mortgage.

You can also consider increasing your income and using the extra cash to pay down your mortgage. Consider tactics such as working overtime, asking for a raise at your next annual review, or starting a side business.

Refinance Your Mortgage

It may make sense to refinance your mortgage to help you build home equity. Although the amount you’ll owe on the new loan won’t decrease, you may be able to own more of your home in several ways.

One, even if you refinance to the same mortgage term, your monthly payments may be lowered, especially if you refinance to a lower interest rate. You can then take the amount you’ve saved and put it towards extra payments.

The other way that refinancing can help you pay down your mortgage sooner is if you shorten your loan term. Even if you don’t make extra payments, you can still pay down your home loan sooner because of the shorter term.

Keep in mind that if you shorten your loan term, your monthly payments will increase. Be sure to review your budget to make sure you can afford to take on the new loan payments. When you shorten your term, you’re committed to the new, higher monthly payments, and being behind could pose huge risks, especially if your loan goes into default.

Remodel Or Renovate Your Home

When your home value increases, so will your home equity because the percentage of the amount you own goes down. In some cases, you don’t have to do anything — if the housing market is strong and home values increase in your area overall, then it’s most likely yours will too.

However, you may be able to increase the chances of increasing your home’s value by remodeling or renovating your home, and therefore the amount of equity in your home. Not all home renovations increase your home value — it’s a smart idea to speak with an experienced real estate agent in your area to see what can help.

In many cases, adding curb appeal, remodeling your kitchen and main bathroom can increase the chances your home’s market value will go up.

Stay In Your Home Longer

Typically, the longer you stay in your home, the more home equity you can amass, though that’s dependent on how much money you put toward the mortgage principal. Plus, staying longer in the home increases the chance your property increases in value automatically, especially if you live in what’s considered a booming area, or you’ve made a series of renovations over time that increase your home’s value.

How To Use Home Equity

If you’re wondering how to get equity from your home, there are several ways. Once you’ve built up significant equity (typically 20% or more), you can tap into it by taking out lump-sum or partial amounts.

Here are few main ways you access your home equity:

Cash-Out Refinance

A cash-out refinance allows you to swap your existing mortgage for one in a larger amount, and you get the difference in cash. You can use the cash for almost any purpose, including renovations or paying for your child’s college education.

You’ll need to pay back the amount you borrow with interest.

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. The money is then dispersed as a lump sum — like a cash-out refinance, you can use the money for almost any purpose.

A home equity loan is typically a fixed-rate loan and you can pay it back through different repayment terms (dependent on what the lender offers).

Home Equity Line Of Credit

Unlike a home equity loan, a home equity line of credit (HELOC) is a line of credit but it’s also based on a percentage of your home equity. One approved, you’ll receive a credit limit — much like a credit card — and you can borrow up to this limit (though some lenders have minimum amounts you need to take out). You can pay back the loan and borrow more, known as the draw period.

The draw period can last anywhere from around five to 20 years, and during this time you’re making interest-only payments. After the draw period is over, then the repayment period starts and you’ll be making payments towards the interest and principal.

Whatever options you choose, make sure you research the benefits and risks. That way, you can make an informed decision and choose a method of tapping into your home equity that works for your needs.

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Call our Home Loans Experts at (800) 251-9080 to begin your mortgage application, or apply online to review your loan options.

The Bottom Line

Building wealth with home equity is a long-term endeavor that could pay off as you continue to pay down your loan. There’s the option of home equity loans and cash out refinancing to help you access your home equity.

To get a loan, make sure you check your credit score – the higher it is, the more likely you’ll be approved with more favorable terms and rates. You’ll also need to know how much equity you have and show lenders you’re able to pay back the loan. The Rocket Mortgage® mortgage calculators can take the guesswork out of many of these factors, helping you to tap into your home equity.

Sarah Li Cain

Sarah Li Cain is a freelance personal finance, credit and real estate writer who works with Fintech startups and Fortune 500 financial services companies to educate consumers through her writing. She’s also a candidate for the Accredited Financial Counselor designation and the host of Beyond The Dollar, where she and her guests have deep and honest conversations on how money affects our well-being.