Your home equity can be a valuable resource to you, depending on your financial situation. Your equity is the interest you have in your home, as the owner. Your equity increases over time in two ways. Equity increases if your property value goes up or if you work toward paying down the balance of your mortgage loan.
Equity is the part of your home that you truly own if you borrowed money to buy it. If you did get a mortgage, the lender has an interest in your property until you pay it off, despite you being considered the homeowner.
The equity you have in your home is considered one of the most valuable assets you have.
Since it is an asset, you can use it. There are three main ways people use the asset of their equity. One is to sell your home. If you decide to move, you receive your equity from the proceeds of the sale. You can also borrow against the equity, and you can use a reverse mortgage to fund your retirement.
Buying a New Home
If you sell your home, you can put the equity aside, or you can use it to buy a new home.
If you have, let’s say $70,000 in equity in your home, then you’ll have a profit after closing. That profit can then be used for your down payment on your next home.
The bigger the down payment, the more expensive the home you may be able to afford. Your mortgage payments may be lower with a bigger down payment as well.
Borrowing Against Your Equity
Another way to use equity is to borrow against it. There are three primary ways to do this—a home equity loan, a home equity line of credit, or a cash-out refinance.
When you use your home’s equity as a way to borrow money, you’ll get a lower interest rate than you likely would with something like a credit card or personal loan.
There’s a downside too. If you don’t make your payments, a lender could foreclose on your home. This wouldn’t be the case if you were to use credit cards, for example.
A home equity loan is somewhat like a second mortgage. You can use the proceeds of a home equity loan however you want, and you pay it back in monthly installments with interest added. It works very much like a traditional mortgage.
A home equity line of credit is structured more like a credit card in that a lender gives you a credit limit based on your equity. You borrow as you need with a HELOC and also pay it back as you borrow.
A cash-out refinance lets you refinance for more than what’s owed on your mortgage, and you get the extra money as cash that you can use.
How to Build Equity
Since equity is a valuable asset that gives you financial flexibility and options, building it is an important goal.
One of the fastest ways someone builds equity is by coming up with as large a down payment as possible. The bigger your down payment, the more equity you’ll have right away.
If you already have a mortgage, make every effort to pay it off. When you first start paying a mortgage, smaller amounts go toward your principal, and more goes toward your interest. However, the longer you’ve had your mortgage, the more goes toward your principal, helping you build equity.
If you ever have opportunities to pay more than the minimum on your mortgage payment, do it. Some people make an extra payment each year, or they make biweekly payments. Even paying just a little more each month can help you reduce your principal balance and increase your equity faster.
If you stay in your home longer, you build more equity, particularly if it increases in value.
Finally, certain renovations that add value can also help you build equity. For example, adding a bathroom or doing a kitchen remodel can improve your home’s value, increasing your equity.