If you’ve owned your home for some time or the market has recently gone up, chances are you’ve built up equity. But how can you use it, and are there other ways to build equity in your home? In this guide, you’ll discover the answers to these questions and ways to convert your equity into cash.
Understanding Equity in Real Estate
Equity is a key advantage of homeownership. Knowing how it works and the different ways to access it can help you tap into extra capital when you need it the most.
What Is Equity in Real Estate?
Home equity is the difference between your home’s current value and your outstanding mortgage balance. So, if your home is worth $395,000 and you owe $325,000 on your mortgage, you have $70,000 in home equity.
How Equity Is Calculated
Home equity is the difference between your property’s market price and the balance on your mortgage. A lower mortgage balance and a higher home value lead to more equity.
The Importance of Equity in Real Estate
Building equity gets you closer to full ownership of your home. When you own your property outright, you no longer have to make mortgage payments. That will give you more room in your budget for other expenses. You can also borrow against your home equity to fund various expenses, such as a vacation, home improvements, or anything else.
Factors Influencing Real Estate Equity
There are a few factors that influence the amount of equity you have in your home. Here’s the list:
- Your down payment: A higher down payment gives you more equity in your home and reduces how much you pay in interest.
- Mortgage payments: Each mortgage payment increases the equity in your home. Paying interest on your mortgage does not build equity. That’s why some people prioritize paying off their balances sooner to build equity faster and reduce their lifetime interest payments.
- Home appreciation: If your house gains value over time, the appreciation turns into equity. Some homeowners get more equity because their properties gain significant value over time.
How Do You Build Equity in Your Home
Beyond home value increases due to changes in the real estate market, there are a few other ways to build equity in your home.
Buying a Home
You will never build equity if you rent. Saving up enough money to make a down payment ensures your monthly living expenses contribute to equity growth. Some loans have very low down payment requirements that make homeownership more accessible.
Make Home Improvements
Some home improvements can substantially improve your home’s value. For instance, you could renovate your kitchen or bathrooms, finish your basement, add an extra bedroom or bathroom, expand the living area, or upgrade your landscaping.
Pay Off Your Mortgage
This will take time unless you’re sitting on a wad of cash. Still, you can speed up the repayment process and build equity faster by making extra principal-only payments each month. Notify the mortgage company that the overage should be allocated to the principal balance. Otherwise, they will apply the extra funds to interest, homeowners insurance and property taxes.
Increase the Down Payment
You also can move into the home with instant equity by increasing the down payment. To illustrate how this works, assume you want to buy a house for $350,000. The mortgage lender in this example only requires a 3 percent down payment ($10,500), which means you’ll owe $339,500 ($350,000 – $ 10,500) and have equity of $10,500 ($350,000 – $339,500) if you go this route. But if you increase your down payment to 10 percent ($35,000), you’ll owe $315,000 ($350,000 – $35,000) on the mortgage and move into your home with $35,000 ( $350,000 – $315,000) in equity.
Market Appreciation
Your home’s equity will go up if its market price also increases. Market appreciation increases the gap between your home’s value and the remaining balance on your mortgage. All of the market appreciation is yours to keep. If your property gains $50,000 in value, you catnip into an additional $50,000 worth of home equity.
How Do You Lose Home Equity?
Unfortunately, there are also ways you can lose equity in your home.
Refinance to a Larger Mortgage
If you refinance into a larger mortgage to pull cash out of your home, you’ll also see a decline in your home equity. This is usually done through a cash-out refinance, which lets you convert up to 80 percent of your home’s equity into cash.
Get a Second Mortgage
Some homeowners also take out a second mortgage, like a home equity loan, to convert equity into cash. Unfortunately, like cash-out refinances, they also cause you to lose home equity.
Damage or Disrepair to Your House
The value of your home will decline if it sustains damages and you fail to make the much-needed repairs. In turn, you will also lose equity.
Examples of What You Can Use Your Home Equity from Real Estate
In most instances, homeowners are free to use the equity they pull out however they see fit. Here are some common uses:
1. Renovate Your Home
Instead of going out and buying the home of your dreams, you can make upgrades to your current property. That way, you won’t have to spend hours on end searching for the perfect home or fork over a hefty down payment and closing costs to buy a new place.
2. Make a Large Purchase
Whether you want to buy a second home, purchase your dream car or fund your child’s education, you can use the equity in your home to make it happen.
3. Pay Off Debt
The monthly payments on high-interest debt can place a dent in your wallet. But, depending on how much you owe, they could also cost you several hundred or thousands of dollars more in interest. Or you can tap into your home equity, eliminate those pesky balances and free up funds to meet other pressing financial goals.
4. Start Your Own Business
Do you have an innovative business idea that can help you live life on your own terms while making a difference? The good news is you can turn your business dreams into a reality by tapping into your home equity.
5. Pay for College
The equity you build up in your home can help pay for your child’s college education. Tuitions are getting higher, and knowing you have extra capital in your property can make it less stressful from a financial perspective.
6. Buy Investment Property
Some homeowners and real estate investors use equity to scale their real estate portfolios. These individuals will take out equity from one of their homes to afford the down payment for another property. Some investors continue this cycle as long as their rental properties generate positive cash flow.
In theory, you could continue to leverage your properties if they yield positive cash flow. However, over-leverage can lead to losses and hard decisions if you end up with more vacancies than you expected. A gradual approach can benefit real estate investors who decide to pursue this path.
7. Or Just Get Cash for Anything
You can use home equity for any purchase. It doesn’t have to be utilized for education or an investment. If you want extra money for any reason, you can tap into your home equity. Homeowners can use their extra financial safety net to cover expenses as they arrive.
How to Access Your Home Equity
Both home equity loans and HELOCs are traditional ways to access your home equity. But if you’d prefer not to take out a loan to convert your equity into cash, consider a co-investment. It gives you cash today in exchange for a share of the future increase or decrease in your home’s value and does not interfere with your agency as the sole owner of your home. You may be eligible for a co-investment of a percentage of your home equity. There are no monthly debt payments.
