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Your home is one of the largest investments you’ll make in your lifetime, but it can feel like it ties up your funds. What if you could tap into the equity and get cash to use as you want?
You can with the many mortgage products available today. As long as you have decent credit and can afford the payments, homeowners can often tap into up to 80% of the equity they’ve built in their home.
Here’s everything you must know about home equity and how it works.
What is Home Equity?
Home equity is the portion of the investment in your home that belongs to you. If you’re like most people, you need financing to buy your home – you don’t have the cash to purchase it outright. When you use financing, the portion of the home’s price that you put down on the home becomes your equity while the remainder is tied to the mortgage.
Fortunately, as you make your payments, you build more equity in your home, but there are other ways to increase your home’s equity too.
Once you pay off your mortgage, you have 100% equity in your home, but that can feel like a pipe dream when you first buy your home. Fortunately, there are other ways to build equity in your home and access it, so you have the money you need for other uses without selling your home.
How do you get Equity in your Home?
You get equity in your home in a few ways – the most common is making your monthly payments, but there are other ways too.
Make your Payments
When you make your regularly scheduled mortgage payments, you pay some principal each month. A portion of your payment goes to interest too, but each month your interest charges decrease as you pay the principal balance down.
If you look at the amortization schedule provided at the closing, you’ll see just how much equity you’ll have in your home with each payment. At the start of the schedule, you pay more interest than principal, but as you pay the principal balance down, a larger portion of your payment goes toward principal versus interest.
Home Appreciation
Homes naturally appreciate, typically an average of 3.5% – 3.8% per year. This means each year you earn a little more equity in your home. If you bought your home for $200,000, for example, the next year it may be worth around $207,500, giving you a little more equity on top of the equity you earned by paying your principal balance down.
Of course, every home appreciates at a different level and appreciation varies throughout the years – some years your home may appreciate more or less than others.
Calculating your Home Equity
It’s easy to calculate the equity in your home. You need just two numbers – the amount of outstanding principal on your mortgage (all mortgages if you have more than one) and your home’s current value.
If you aren’t sure of your home’s current value, use sites like Zillow or Chase to get an estimated value. You could also ask around to see how much homes in the area sold for recently, just make sure they’re similar to your home.
Once you have these numbers, subtract the amount you owe on your mortgages from the home’s value, and you have your home equity.
For example, if your home is worth $300,000 and you owe $100,000 in mortgages, you have $200,000 in equity. We can always help you determine how much equity you have in your home if you aren’t sure too.
5 Tips to Increase your Home Equity
Making your regular payments and enjoying natural home appreciation is a great way to build equity, but there are other ways to speed it along if you want to increase your home equity.
1. Make a Large Down Payment
When you buy your home, you have the option to make the minimum down payment required or a higher down payment. If you have the cash and don’t need it for emergency funds, reserves, or other financial goals, consider putting it down on your home.
The money you put down is instant equity in your home. Not only does it give you a higher amount of equity, but it also lowers your mortgage payment because you borrow less, and it may even help you get better loan terms.
If you tie money up in your home and later need it, you can always refinance to take the money out of your home.
2. Make Extra Mortgage Payments
You must make your minimum mortgage payments each month, but you can also pay extra. Most loans don’t have prepayment penalties any longer so you can pay as much as you want each month.
To build equity in your home, create a budget that allows you to make extra payments. It can be as little as $100 a month, bi-weekly payments, one extra payment a year, or even lump sum payments you make when you have windfalls.
You can make regular extra payments or sporadically pay your mortgage down when you have the extra funds. Any way you do it will increase your home’s equity instantly.
3. Improve your Home
Some home improvements increase your home’s value. Don’t expect a dollar-for-dollar increase, though. Kitchen and bathroom improvements have the highest impact on your home’s value, but other renovations may help too.
If you aren’t sure if the renovations, you’re considering will increase your home’s value, talk to a local appraiser or real estate agent to get their opinion. Sometimes simple changes like a fresh coat of paint, increased curb appeal, or updating fixtures are enough to increase your home’s value.
4. Make 15-Year Payments on a 30-Year Loan
If you took out a 30-year mortgage, you could still pay your loan off in 15 years by making 15-year payments. Using a mortgage calculator, figure out how much you must pay to pay the loan off in 15 years.
Some people choose this option versus refinancing to avoid having the obligation to make 15-year payments in case they can’t afford the higher payment every month.
5. Refinance your Mortgage
Refinancing your mortgage for a lower rate or into a shorter term is a great way to increase your home equity.
If you can afford a shorter term, it’s the fastest way to increase the equity you build in your home. A larger portion of your payment will go toward principal since you have less time to pay the debt off and you’ll have a lower interest rate because shorter terms have lower rates.
If you can’t afford the shorter term, just taking advantage of today’s lower rates is a great way to increase equity since a smaller amount of your payment will go toward interest with a lower rate.
How to Get the Equity in your Home
Once your money is tied up in your home, it can feel like it’s stuck there until you sell the home, but that’s not the case. We offer several ways to access your home’s equity.
Cash-Out Refinance
A cash-out refi is a refinance of your first mortgage. You refinance the amount you owe on your current mortgage plus any equity you want to take out of the home.
Most homeowners can tap into up to 80% of their home’s value. For example, if your home is worth $300,000, you can take out a cash-out refinance up to $240,000. Of course, how much you can borrow depends on your qualifying factors and the amount of your first mortgage.
Assuming you qualify for the payment on a $240,000 loan, any difference between the $240,000 and the amount of your outstanding mortgage is cash you can receive.
Home Equity Loan
A home equity loan is a second mortgage on your property. It doesn’t touch your first mortgage, which is a nice option for those who have a low interest rate on their first mortgage and don’t want to lose it.
Home equity loans have a fixed interest rate and pay you the equity you can tap into in one lump sum. Like the cash-out refinance, you can tap into up to 80% of the home’s value minus any first mortgage liens you have on the home.
Home Equity Line of Credit
A HELOC is also a second mortgage on your home, but it works differently than a home equity loan. A HELOC is a line of credit that you can access as you want/need throughout the first 10 years.
Like all other options, you can tap into up to 80% of the home’s equity, but you use the money like a credit card line. You get access to the funds with a debit card or checking account and can use the funds as you need. You must make interest payments on any amount you withdraw (use) but can also pay back any principal too.
If you pay back the principal, you can reuse the line of credit throughout the draw period, which lasts for 10 years (just like a credit card). After the 10 years, the loan enters the repayment period when you’ll owe principal and interest payments to pay the loan off in the next 20 years.
Ways to Use the Equity in your Home
Fortunately, you can use the equity in your home however you want – we don’t tell you what you can do with the money. Here are the top ways homeowners use the funds though.
Home Improvements
What better way to use your home’s equity than to reinvest in your home? When you use the funds to improve your home, you increase its value and earn the equity right back. This is often a more favorable way to cover the cost of home improvements since home equity loans or even a cash-out refinance has lower interest rates than personal loans or credit cards.
Debt Consolidation
If you have a large amount of high-interest consumer debt, you can pay it off using your home’s equity. Since mortgage loans usually have a much lower interest rate than credit cards or personal loans, you can pay less interest and pay the debt off faster.
You’ll also have the convenience of having one payment to handle each month versus several. This makes it easier to stay on track with your payments and to get out of debt faster.
Pay for Large Expenses
Other great uses of the equity in your home include:
- Tuition for college
- Tuition for private schools
- Large purchases for your home
Emergency Fund
If you don’t have an emergency fund, having the funds from your home’s equity can provide peace of mind. Many homeowners take out a HELOC and save it for emergencies. If they never use it, they don’t have to worry about interest charges, but if they need it, they know it’s there.
Final Thoughts
Your home’s equity is yours to do what you want with it. As long as you have decent credit and can afford the monthly payments, you can tap into your equity.
Before you use your home equity, think about what you’re doing with it. Since you’ll be taking out secured debt (your home is the collateral), make sure you’re using the funds for something worth putting your home at risk.
Whether you want to make home improvements, are tired of your high-interest debt, or have other plans for the money, there are many ways to get the profits you’ve made in your home out so you can enjoy your money while you can!
