Becoming a homeowner comes with a long, seemingly never-ending list of expenses. From upfront costs like your down payment and closing fees—to unexpected repairs, insurance, taxes, and more—it’s easy to sometimes feel like your home is more of a financial burden than an asset.
But, that’s not exactly true. Each time you make a payment toward your mortgage’s principal balance, you’re slowly building home equity. This can be a helpful card to have up your sleeve.
What is home equity—and why it matters
Home equity is the percentage of your home that you own outright. Calculating your equity is as simple as taking the fair market value of your home, and subtracting what you owe on it. Just remember that it will fluctuate as the market value of your home changes and you make payments toward your mortgage.
“Building up home equity can be a great way to financially prepare for retirement or accomplish other long-term financial goals,” says Alex Shekhtman, CEO and founder at LBC Mortgage.
There are several ways a home equity loan can help you build long-term wealth. The funds can be reinvested back into your home through home improvement projects that will boost its market value and help you turn a profit if you sell. Or you can use a home equity loan as a down payment on a rental property to jump-start a passive income stream.
Other expensive milestones like you or your child’s education can also be financed by a home equity loan. While there are risks involved, a home equity loan can provide an additional, more affordable financing option for life’s more expensive milestones.
There are many things you can use home equity to pay for:
- Home improvements: Major home renovations or upgrades can be costly. However, you do have the option of using your home as collateral for a home equity loan to cover the cost of those projects. Making these improvements can significantly increase the value of your home and help you boost that equity even more.
- College costs: Home equity loans tend to have lower borrowing rates compared to other types of debt. You could use a home equity loan to pay for educational costs. Just keep in mind that this option is risky because this could put you at risk of losing your home if you default on the loan. You could also miss out on certain loan protections and forgiveness programs available for federal student loan borrowers.
- Debt consolidation: If you’re carrying any high-interest debt balances, you can use a home equity loan to pay down those balances and secure a lower APR. Say you’re carrying a steep balance on a credit card with a 17% APR. Consolidating and paying off your original balance with a home equity loan that offers a 7% APR could considerably cut down on the amount you’re paying in interest each month and the amount of time it takes you to repay the balance.
- Emergency expenses: Using a home equity loan or a HELOC to cover an emergency expense should never be your first resort. You should aim to build a healthy cushion in an emergency fund to cover unexpected expenses. However, having home equity to borrow against can be a useful financial safety net in a tough situation.
There are several reasons why you may decide to take out a home equity loan or HELOC, but the risks still stand. Using this kind of financing can give you access to lower interest rates and more manageable terms, but you could end up owing more money down the line if your home’s value declines. You could also lose your home altogether if you find yourself unable to repay the amount you borrowed.
5 ways to increase your home equity
So, how do you increase your home equity? There are a few approaches you can take.
- Make a larger down payment: Building home equity begins the second you make a down payment on your home. Some homeowners put down as much as 20% of their home’s purchase price, others start with as little as 5% down, depending on the kind of financing they’ve secured. So making a larger down payment means that you’ll have more equity in your home to start, giving you a headstart to paying off your mortgage more quickly.
- Make extra payments toward your mortgage: Paying more than the minimum monthly payment on your mortgage is one way to speed things up. Bigger payments will cut down on the amount of time it takes you to pay off your mortgage in full and increase the rate at which you’ll naturally build equity.
- Home improvement projects: Certain home improvement projects can boost your home’s overall value and, in turn, increase your home equity. According to Remodeling Magazine’s 2022 cost versus value report, improvements like garage door replacement, adding a deck, or adding new siding and windows to your home can all provide a significant return on your investment.
- Choose a shorter-term mortgage: Opting for a 15-year mortgage, for example, rather than a standard 30-year mortgage, means that you’ll pay off your home in half the time, build equity a lot faster, and save money on interest. Just know that with this option, you’ll have less time to spread out your mortgage payments and will be responsible for a larger monthly payment.
- Refinance to a shorter-term loan: If you’ve already paid off a significant portion of an existing longer-term mortgage, you can refinance it and take out a home equity loan for more than you currently owe on your home. This is known as a cash-out refinance, and it will give you extra funds to tap into for any major home renovation projects or expenses coming your way, although the same risks related to higher monthly payments and potential foreclosure apply.
How long does it take to build equity?
Building equity takes time. In fact, a common rule of thumb in the real estate industry known as the five-year rule holds that homeowners should be prepared to keep their homes for a minimum of five years before even considering selling, to recoup their upfront costs and avoid any risk of losing money. The idea behind this rule is that your home will appreciate in value over time and the more equity you’ve built, the less you stand to lose by selling.
The exact amount of time it’ll take you to build equity in your home will depend on the strategies you use to get there. If your strategy is to make your monthly mortgage payment and let time do the work for you, it could take a bit longer than someone who is looking to supercharge the process by making extra payments and investing in home improvements to boost their equity.
Your home is one of the biggest and most important investments you’ll ever make. And getting the most out of that investment means actively working to build and maintain your home equity. Even if you don’t have any plans of selling your home in the future, home equity can give you an added layer of financial protection and stability.
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