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7 ways to build equity in your home
You may dream of the day you pay off your mortgage in full and don’t have to make monthly payments anymore. But there are other benefits to paying down your loan too — the main one being that you get to build equity.
Home equity is the accrued paid-off portion of your home. You can receive that equity as cash with a cash-out refinance or second mortgage, then use the money to pay for other big expenses. You may also view your home equity as money that could help you with a down payment on a future home. Owing less on one home certainly helps when you want to sell it to buy another.
Understanding home equity is crucial to learning how to build more and use it to your advantage.
In this article:
What is home equity?
Home equity is the percentage of your mortgage you’ve paid off and own outright. The easiest way to estimate how much equity you have is to subtract the remaining mortgage principal from the market value of your home. You can use comparisons of houses similar to yours or undergo an appraisal to get a better idea of the market value of your house. Or, to be conservative, you can simply subtract how much you owe from the amount you paid when you bought it.
For example, let’s say you bought a house for $500,000 and have $350,000 left on your mortgage. Here’s how to determine the amount of equity you have:
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$500,000 - $350,000 = $150,000. You have $150,000 in home equity.
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$150,000 is 30% of $500,000 (150,000 divided by 500,000 =0.30%), so you have 30% equity in your house.
Of course, these numbers could change if market values have increased or decreased since you bought the home or if you’ve made significant updates to increase the home’s value. But these equations will give you a basic idea of how to calculate your home equity.
Why is building home equity important?
Building equity in a house is a good thing because it helps homeowners build wealth. The more equity you have in your home, the more you’ll pocket if you sell. The home can be a valuable asset to pass down to the next generation too.
Having equity in your home also gives you a way to cover bigger purchases. If you face a financial emergency or hefty medical bill, you can use a home equity loan or home equity line of credit (HELOC) to tap your equity and receive cash. This can be a better option than charging a large expense to a credit card, which usually charges a higher interest rate than these second mortgages.
Dig deeper: How to choose between a home equity loan and a HELOC
7 tips for how to build equity in a home
Building equity in your home happens naturally as you make your regular monthly mortgage payments. However, by using one or more of the following tips, you could build equity faster without drastically altering your monthly budget.
The following tips use a house with a $400,000 mortgage, 30-year term, and 6% fixed interest rate as an example.
1. Stay in your home for several years
Building equity from paying down your mortgage loan takes time. At the beginning of your loan, most of your payment goes toward mortgage interest. As time passes, less and less goes toward interest, and more goes to paying down the actual principal. The longer you stay in the home, the more principal you’ll pay off. For the $400,000 30-year mortgage with a 6% interest rate, you would pay off over $27,000 in five years.
Staying in your home longer also gives time for market prices to rise, so your house may be worth more than if you sold it after just one or two years.
2. Make biweekly payments
Biweekly mortgage payments can speed up your repayment because you will make two extra payments annually. By making biweekly payments on a $400,000 loan with a 6% interest rate, you’ll pay off your mortgage in just shy of 25 years. So, not only will you gain equity faster, but you’ll also pay off your mortgage sooner.
3. Make surprise extra payments
If you get extra cash from a tax return, workplace bonus, or inheritance, making a one-time extra payment on your mortgage bumps up your equity. Just verify with your mortgage lender that the extra payment is going toward your principal, not interest. Paying extra toward interest will not increase your equity.
Learn more: Should you make one extra mortgage payment per year?
4. Pay extra toward your principal regularly
As little as $10 or $20 monthly can reduce your mortgage repayment time frame by a few months. For example, adding an extra $20 per month on a $400,000 mortgage increases your equity by almost $1,400 in the first five years. This strategy also cuts eight months off the end of your 30-year mortgage term.
5. Avoid a cash-out refinance
A cash-out refinance is one tool for tapping your home equity. But it involves taking out a larger loan so you can receive some of it in cash. If you take money out of your home, you are reducing accrued equity.
While a cash-out refi may be a good option for other reasons, it isn’t a good tool for building equity.
6. Get rid of PMI
If you made a down payment of less than 20% on a conventional mortgage, you’re probably paying for private mortgage insurance (PMI) every month. Once you have 20% equity in your home, request that your mortgage lender remove the PMI. At 22%, the lender should automatically remove PMI.
Once you’re done with PMI payments, you can keep putting that amount toward your monthly mortgage payment. Instead of going toward mortgage insurance, this money will now help you gradually build up your equity.
Dig deeper: How to get rid of PMI and lower your mortgage payments
7. Choose home improvements wisely
Remodeling or making major home improvements can increase your property value. When deciding which improvements to make, consider how much value they will add to the house.
For instance, replacing your roof might make your home more appealing to buyers (especially if your current roof is already fairly old), but a new roof is also very expensive. On the other hand, painting the interior of your house is a more affordable way to make the home look and feel nicer.
Building home equity FAQs
Is building equity in a home a good thing?
Building equity is beneficial because it helps you accumulate wealth and provides a source of income should you need access to cash for a large expense.
What builds the most equity in a home?
Aggressively paying down your mortgage principal is a great way to build equity in a home. Another option is making home improvements that add value to the house and aren’t too expensive.
How much equity do you build in five years?
The amount of equity you accumulate in five years depends on the size of your home loan. You typically don’t build as much equity at the beginning of your loan term because most of your monthly payments go toward interest. As time goes on, more and more will be applied to your principal balance.
This article was edited by Laura Grace Tarpley.
